SUMMER 2005

THE FEDERAL RESERVE BANK OF RICHMOND UNDER SCRUTINY Is Sarbanes-Oxley Working as Planned?

• Tobacco Buyout • Bankruptcy Reform • Freakonomics • Milton Friedman on Price Controls VOLUME 9 NUMBER 3 SUMMER 2005 COVER STORY Our mission is to provide 13 authoritative information Lights Out: Three years after the enactment of the and analysis about the Fifth Federal Reserve District Sarbanes-Oxley Act, questions are mounting about economy and the Federal unintended consequences for hundreds of U.S. firms Reserve System. The Fifth In an age of stepped-up regulatory scrutiny, more companies are deciding District consists of the the costs of being publicly traded or listed on a major stock exchange District of Columbia, are no longer worth it. That’s not exactly what lawmakers had in mind. Maryland, North Carolina, South Carolina, Virginia, and most of West Virginia. FEATURES The material appearing in 19 Region Focus is collected and Tobacco Buyout: The invisible hand plants first crop developed by the Research For the first time since the 1930s, tobacco growers will enter a market Department of the Federal largely free from mechanisms that restrict supply and guarantee prices. Reserve Bank of Richmond. 22 DIRECTOR OF RESEARCH Redevelopment Boot Camp: Will military-centric commu- John A. Weinberg EDITOR nities find ways to turn barracks and bombing ranges into Aaron Steelman

something marketable? SENIOR EDITOR Communities like Blackstone, Va., show that base redevelopment works Doug Campbell

best when it uniquely addresses an existing need in the marketplace. MANAGING EDITOR 26 Kathy Constant A Menu of Options: A Richmond Fed economist says that giving BUSINESS WRITERS Charles Gerena financial institutions limited choice about how they are regu- Betty Joyce Nash

lated may produce a more stable and efficient banking system EDITORIAL ASSOCIATE What’s the best way to supervise banks? It may be to create a system with Julia R. Taylor

incentives that help keep risky banks from declaring themselves safe. CONTRIBUTORS 30 Kartik Athreya Joan Coogan Youth Movement: Blacksburg, Va., and Morgantown, W.Va., Andrew Foerster are counting on their local universities to create more jobs. Eric Nielsen Christian Pascasio Is that realistic? Jennifer Sparger Virginia Tech’s research park has been a boon for Blacksburg. But the ECONOMICS ADVISERS farther away from campus, the fewer the benefits. Andrea Holland 34 Robert Lacy From the Classroom to the Workplace: So, where are the jobs? Ray Owens DESIGN Hiring is up for new graduates but are all degrees created equal? Ailsa Long

35 CIRCULATION Making it on the Reservation: The Eastern Band of the Walter Love Cherokee Indians shares the economic problems that Shannell McCall afflict tribes and rural communities nationwide Published quarterly by the Federal Reserve Bank With pragmatism and a determination to survive, the Eastern Band has of Richmond faced the challenges of federal Indian policy, land use, and rural living. P.O. Box 27622 Richmond, VA23261 www.richmondfed.org DEPARTMENTS Subscriptions and additional copies: Available free of charge 1 Noteworthy/Retail Credit Expansion and Regulatory Overreaction by calling the Public Affairs 2 Federal Reserve/“How Not to Stop Inflation” by Milton Friedman Division at (804) 697-8109. 8 Short Takes Reprints: Text may be reprinted COVER STORY with the disclaimer in italics 10 Jargon Alert/Monopoly below. Permission from the SEE PAGE 13 1 1 Research Spotlight/Why Regulations Fail — Yet Persist editor is required before reprinting photos, charts, and 12 Policy Update/Freer Trade in Textiles Changes Import Sources tables. Credit Region Focus and 39 Economic History/High Tech Down South send the editor a copy of the publication in which the 42 Interview/Robert Whaples reprinted material appears. 46 Book Review/Freakonomics: A Rogue Economist Explores the The views expressed in Region Focus Hidden Side of Everything are those of the contributors and not COVER: necessarily those of the Federal Reserve PHOTOGRAPHY: CHRISTIAN ZACHARIASEN/GETTY IMAGES 48 District/State Economic Conditions Bank of Richmond or the Federal INSIDE COVER: 56 Opinion/The Economics of Bankruptcy Reserve System. PHOTOGRAPHY:PHOTOGRAPHY: AP/WIDE STOCKBYTE/GETTY WORLD PHOTOS IMAGES ISSN 1093-1767 NOTEWORTHY Retail Credit Expansion and Regulatory Overreaction

t the turn of the 20th So once again we have an episode of expanding credit century, working Ameri- accompanied by a regulatory response. Among the most Acans had relatively few recent measures, North Carolina has enacted legislation that attractive options for obtaining limits certain practices in the subprime market. At the credit. Often, they took out loans national level, the data that lenders are required to submit with high costs and inscrutable under the Home Mortgage Disclosure Act now must include terms. Worried about this trend, information on interest rates if they exceed a certain spread New Jersey passed the country’s over funding costs. Some advocates have recently proposed first small loan laws in 1914. expanding credit card disclosure requirements to include, Like similar measures to follow for example, the time it would take to repay the bill while just in other states, the New Jersey making the minimum payments. Improved disclosure can legislation included requirements strengthen consumers’ understanding of financial products that lenders who charged more and increase the odds of consumers getting the product that than the legal interest rate for banks be licensed and that bor- is best for them. But to the extent that increased disclosure rowers be informed about the precise terms of their transaction. requirements are simply a prelude to other measures that More than any other effort in the early 1900s, small loan laws would reduce the availability of credit, we should be wary. were credited with helping to protect poor borrowers from When weighing measures designed to protect borrowers, price gouging. we should always keep in mind the inherent trade-off between We have witnessed a similar pattern over the past preventing adverse effects for some and limiting the avail- 100 years. When new forms of retail credit have become ability of credit to others. The evidence suggests that available, there has often been a political response, ranging constraints on allowable interest rates are counterproductive from disclosure rules for installment lenders in the 1920s to and generally reduce consumer well-being. While some curbs on payday advances in the 1990s. Sometimes these policies that carefully target truly abusive practices are responses have been driven by populist aversion to financial warranted, the broader risk is of a regulatory overreaction institutions; sometimes by sound economic principles. that stifles much of the benefit of the technology-driven Occasionally, they have been counterproductive. expansion in consumer credit. It is important to remember these lessons of history. One thing I think everybody can agree on is the usefulness The United States is currently experiencing what can of educating consumers about managing their financial arguably be called a revolution in retail consumer finance, affairs. Financial institutions depend critically on their one of the greatest credit expansions in history. And with it customers’ trust, and trust is built on their understanding the we are encountering the anticipated policy responses. While difference between a legitimate financial transaction and one in general we would expect that regulations ought to adapt that is too good to be true. Beyond that, an electorate that to changing credit market practices, there is a very real has a broad appreciation of the efficiency of credit markets danger here of regulatory overstep. It’s important to will have an easier time sorting out when any particular remember that, on the whole, the expansion of retail credit policy proposal is truly in its interests. has been tremendously beneficial. Limiting this expansion The United States has arguably the most efficient retail might have the undesirable effect of preventing the people credit markets in the world. We should avoid regulatory most in need of credit from obtaining it in the first place. actions that would threaten a system that has served so many Over the past 15 years, technological advances have people so well. reduced the cost of gathering, processing, and retaining consumer account information. These savings have been passed along to borrowers in the form of lower lending rates. Credit cards, which used to be available almost exclusively at high interest rates, are now offered at lower rates to a JEFFREY M. LACKER broader market of creditworthy customers. PRESIDENT The upshot is that more people today can afford to FEDERAL RESERVE BANK OF RICHMOND borrow. Because credit allows people to choose a spending pattern that is smoother over time than their income stream, Editor’s Note: This article is based on a speech given on June 14, 2005, at the the expansion of retail credit over the last two decades has annual meeting of the North Carolina Bankers Association. To read the yielded positive net benefits for American consumers. speech in its entirety, please visit our Web site: www.richmondfed.org

Summer 2005 • Region Focus 1 FEDERALRESERVE How Not to Stop Inflation BY MILTON FRIEDMAN

EDITOR’S NOTE: High and rising in- et me turn to my topic for This analogy is suggestive but does flation can tempt policymakers to enact tonight, “How not to stop not go far enough. If you broke the inflation.” As you know, the word thermometer, that would neither quick “fixes,” such as wage and price L “inflation” has a great many different make it hotter nor do any other harm. controls. But as Milton Friedman argues in meanings and people attribute different It would just simply prevent a signal this speech, delivered in February 1966 to conceptions to it. What we mostly of the rising temperature from being the Detroit chapter of the University mean by it, and what I shall mean by it, seen. Prices partly do measure pres- is a rise in prices, in prices in general. sure, but they also affect the course of Chicago Alumni Association, such In the past year or so, we have been of events. Perhaps a better analogy is controls don’t get at the fundamental having a tendency for a rather wide- the following: When it gets too hot source of inflation — excessive expansion spread rise in prices. That tendency in this room, close all the outlets from of the money supply — and eventually seems to give every sign of intensifying the furnace while letting the furnace and increasing, so we have a real run full blast until it bursts. That is make the problem worse. While in effect, problem of inflation. more nearly a correct analogy to hold- the controls often result in shortages of If inflation does consist in a rise of ing down particular wages and prices goods, and when they are removed, the prices — in the price of meat going as a means of stopping inflation. inflationary pressures that have been up, of wages, and of all sorts of things The question is, why is that a bad — then it seems most natural to say way to stop inflation? What harm does bottled up artificially tend to explode. that the way to stop it is to stop prices it do? In trying to suggest to you the Only five years after Friedman deliv- from rising. If you want to stop infla- answer to those questions, I want to ered this speech, President Richard Nixon tion, let’s just pass a law saying that no talk about two main points. The first enacted a program of wage and price price shall rise. That will stop it. The point is to discuss what the source main theme of my talk tonight is of inflation is. If I were putting it as controls. The system was supposed to last to say that this tempting way to stop a topic for a Sunday sermon and only 90 days but proved to be far less inflation is the way not to stop it. could speak French, I would say, temporary, surviving in modified form for It will not in fact cure inflation, but instead of “Cherchez la femme” — nearly three years. The results were even if it did, it would be a cure that is “Cherchez la monnaie.” “Look for the worse than the disease. This approach money.” Inflation is always and every- predictable. The legislation was greeted is like saying that if it’s getting too where a monetary phenomenon. That with initial enthusiasm, but its problems hot in this room, the way to solve the is the first point I want to discuss. were quickly apparent. By the mid-1970s, problem is to break the thermometer. The second point I want to discuss inflation had reached double digits. In his is that while we ordinarily talk about Milton Friedman distinguishing between inflation and memoirs, Friedman wrote that Nixon’s deflation, between rising prices and decision to impose the controls “did far falling prices, there’s another distinc- more harm to the country than any of the tion that I think is even more later actions that led to his resignation.” important. That is the distinction between open inflation and sup- Friedman, who won the Nobel Prize pressed inflation, between an inflation in economics in 1976, taught at the in which prices are permitted to rise University of Chicago from 1946 to 1977 and an inflation in which prices are and is now a senior research fellow at the held down. While inflation is bad, it is far better to have it open than it is to Hoover Institution. This speech, which has have it suppressed. Suppressed infla- been edited for length, has never before tion is the case in which the cure is been published. The full text is available at worse than the disease, like pouring our Web site: www.richmondfed.org coal into the furnace while locking all places where the steam can get out until the furnace blows up. PHOTOGRAPHY: THE UNIVERSITY OF CHICAGO NEWS OFFICE

2 Region Focus • Summer 2005 Let me turn to the first point. The else to hold less. This is a game of to the wholesalers. The wholesalers common approach to inflation is to musical chairs in which the pieces of say, “Our costs have gone up so we think that inflation, being a rise in paper pass around. While each indi- must charge a higher price,” so they prices, results from a rise in costs. vidual separately can decide how charge a higher price to the retailers. With rare exceptions, every business- much to have, the community as a The butchers say to the housewives man and every ordinary person tends whole has nothing to say about how when next they come in, “We’re very to think that the reason why prices go many pieces of paper there shall be sorry to have to do this to you; it up is because they are pushed up to pass around. That’s determined isn’t our doing, but our costs have because costs go up. This may take by the Federal Reserve Board or the gone up so we have to charge you a the form of a so-called cost-push Treasury or by some central agency. higher price.” Everybody along this spiral or wage-price spiral or other Whatever that amount is, it’s shuffled chain, except way back at that auc- fancy terms, or it may take the sim- around from person to person. tion where there is nobody who has pler form of each man thinking he has I think that’s a very clear and any costs that he can look at in the to raise prices because his costs have straightforward example of how it is same sense, is honestly charging high- gone up. It is perfectly natural that that the way it appears to the individ- er prices because his costs have gone people should think this way because ual is the opposite from the way it up. And yet, taken altogether, the to each individual separately that is appears to the community. The same increase in prices clearly reflects the the way it looks. But the fact is that thing is true with respect to inflation. increase in demand at the final stage. this has almost never been the source The example I can give you which That is the way it is in the economy of inflation. It’s the external manifes- will bring this out most clearly is one at large. Every manufacturer says, “I tation of inflation, but not its source. which I have taken from a recent have to charge higher prices because Indeed, this illustrates a much textbook in elementary economics. my wages have gone up,” but the more general principle. What makes The authors, Armen Alchian and reason his wages have gone up is economics, in my opinion, a fascinat- William Allen, have a wonderful little because there’s been an increase in ing subject is that for almost any story in their book that will illustrate demand somewhere else which has led important proposition in economics, how it is that to each individual sepa- somebody else to try to bid his work- what’s true for the individual is pre- rately it looks as if what causes ers away from him, or he’s been trying cisely the opposite of what’s true for inflation is a rise in costs even though to bid workers away from somewhere everybody together. That’s why you to everybody together what causes it else. The ultimate source of the have so many widespread economic is an increase in demand, a monetary increase in price has been an increase fallacies. People generalize from their phenomenon. Let us suppose, they in monetary demand. individual experience, and yet that is say, that all of a sudden the house- And now we ask the question, precisely the opposite of what holds wives of America decided that they where does that increase in monetary for the community as a whole. Let me wanted to serve more meat on their demand come from? If there has been illustrate that in a very simple way, tables, and so come Monday morning any substantial increase in monetary which is also related to the problem of each one goes to the butcher and demand, it always has had the same inflation. Each one of us separately buys more meat. No butcher raises basic source. Somebody has produced thinks he can decide how many of his price. He just sells out his meat more money. The exact source of these green pieces of paper to keep in and then he orders a larger amount of additional money has varied from his pocket — subject, of course, to his meat from the wholesaler. The whole- time to time. In the period after 1896, total wealth. If any one of us wants to salers sell out and so they order the after William Jennings Bryan was keep $20 more in his pocket, all he has larger amount of meat from the defeated in the campaign for free to do is cash a check for $20 or sell a packer. The packer finds his inven- silver, prices rose in the United States bond for $20 or use $20 of his income tory going down and so he sends back from 1896 to 1913 by roughly 35 per- and keep it in cash instead of spending instructions to the cattle buyers at cent. That price rise came from an it or investing it in some other way. the auctions to buy more animals. increase in the quantity of money So each person separately thinks he Well, of course, there aren’t any more which occurred because some smart can decide how much money to hold animals to be bought, so what people had figured out how to apply in his pocket, and each one is right. happens is that the people trying to the cyanide process to extract gold Yet for the community as a whole, the buy them bid up the price of the ani- from low-grade ore. The resulting amount of currency to be held in mals. They report to the packing great increase in the production of pockets is a fixed number. There are houses, “We’re sorry we’ve had to pay gold brought about an increase in the only so many pieces of these green a higher price for the animals.” The quantity of money, which in turn pieces of paper that have been print- packing houses say, “Our costs have brought about inflation. ed. The way that you get more in your gone up so we must charge a higher To go back to my main theme, on pocket is by persuading somebody price,” so they charge a higher price that occasion, inflation reflected an

Summer 2005 • Region Focus 3 increase in the quantity of money, but therefore, we’ve got to get higher make it stronger there. Suppose you the particular reason why the quantity wages to have the same real income for succeed in keeping down, let us say, of money increased varies from time our employees. So you have a situation the price of steel which has attracted to time. On that occasion it increased in which the government, to blame so much attention. That would simply because of gold. In World War I and somebody else, attributes inflation to mean that the purchasers of steel have World War II, in the United States the a wage-cost spiral, and the business- more money left after buying steel quantity of money increased very rap- men and the labor union leaders than they would otherwise have had idly because government printed it to accept the blame and say, yes, we and they can now spend it on bidding finance the war. Go back to the great are guilty. Yet in fact, as I have empha- something else up. If you keep down price inflation in Europe in the 16th sized, the inflation arises from one the wage rate of labor under these cir- and 17th centuries and that came and only one reason: an increase in a cumstances, it just means that the because of the discoveries of specie in quantity of money. employers have more money to pro- the New World. There have been That is my first point. The next duce inflation somewhere else, so all many reasons why the quantity of point I want to discuss is the harm you are doing is shoving the inflation- money has increased, but inflation has that is done by trying to stop inflation ary pressure over. never occurred to the best of my by holding down wages and prices. But you may say, that’s only knowledge except as a consequence of The president, members of the because we haven’t gone far enough. If a more rapid increase in the quantity Council of Economic Advisers, and we really spread our net wide, if we of money than in output. other prominent public officials make held down every wage and every price, In modern times, the quantity of speeches about the terrible effects there’s no place for the inflationary money is under the control of govern- of inflation and about the urgent pressure to go. That’s true, but let’s mental agencies. In the United States, necessity for businessmen and labor look and see what the consequences it is determined by the Federal union leaders to exercise a social would be. The consequences of that Reserve Board, the Treasury, the mon- responsibility in holding down wages would be to destroy the price system etary authorities. And that means that and prices. Maybe the cause of infla- as a means of organizing economic if inflation is always a consequence of tion is an increasing quantity of activity and you would have to an increase in the quantity of money, money, but you may well ask, what substitute something else. What else the responsibility for inflation is harm would it do to try to stop it by would you substitute? If prices are not always governmental. But, of course, holding down those wages and those going to determine who buys how as you know, no human being likes to prices? much, something else must do it. take responsibility for things that are In the first place, one of the major Let me give you a historical unpleasant or undesirable and so no sources of harm it does is to lead example which perhaps makes my governmental official likes to stand up people and the government to mis- point most strikingly about the impor- in front of an audience and say, conceive the nature of the problem. tance of the distinction between “Mea culpa, I’m responsible for infla- If the businessmen and the labor open and suppressed inflation. It has a tion.” What always happens is that leaders accept the blame, the govern- very real parallel with strong implica- the governmental officials stand up ment goes on pouring coal into the tions for the United States although and say, if we have inflation it’s furnace, increasing the quantity of it’s a much more extreme case. The because of those rapacious business- money, and says that any resulting best example, because it’s almost a men and those selfish union labor inflation is not its fault. So you tend to controlled experiment, is a compari- leaders. If those people would only encourage a delay in adopting the son of experience in Germany after stop demanding more and more, high- remedy which alone can prove effec- World War I and World War II. As er and higher wages and higher and tive, namely, a slowing down in the you recall, after World War I in higher prices, there would be no infla- rate of growth in the quantity of Germany there was an inflation that tion. And the businessmen and the money. That’s only a minor reason really was an inflation. It was a hyper- wage union leaders, surprisingly why it is harmful. A second reason is inflation. A student of mine some enough, tend to accept the indictment that it isn’t going to stop inflation. It’s years back, Phillip Cagan, wrote a because of their misunderstanding like taking a great big balloon and classic study of hyper-inflations, and of the elementary economic point thinking that by pressing one corner he defined a hyper-inflation as begin- I’ve been trying to present here. of it you are going to deflate the bal- ning when prices rose more than The businessmen tend to say that loon. All you do is push the air into 50 percent a month. In Germany the reason we have inflation is because the other part of the balloon. In the during the height of hyper-inflation, those selfish unions push up wages, same way, if you succeed in holding there were periods when prices were and the union leaders say the reason down some wages and some prices, all doubling every day. In fact, it got to we have inflation is because those that does is push the inflationary the point that employers were paying selfish businessmen raise prices and, pressure over somewhere else and their workers salaries three times a day

4 Region Focus • Summer 2005 — after breakfast, lunch, and dinner so they could go out and spend it before it lost value. That was really an infla- tion. Prices went up by amounts that you have to reckon by 10 to the 10th or 10 to the 20th, something like that. The hyper-inflation did tremen- dous harm of a social kind. It destroyed the German middle classes, and it undoubtedly laid much of the socio- logical basis for the subsequent emergence of Hitler. But from a pure- ly economic point of view, the striking thing about it is that, except for the last few months of the hyper- inflation, the level of economic activi- ty remained high. Inflation was open, prices were free to rise, there were no price controls of any kind, and, consequently, people were free to continue to do business. There were controls when there is that big a dis- Friedman (right) with President Nixon certain kinds of inefficiencies pro- crepancy between the market price and George Shultz in the Oval Office in duced but you never had any major and the controlled price. 1971, the year the Nixon administration decline in the aggregate level of But Germany from 1945 to 1948 imposed wage and price controls. production. Indeed, as you may was an exception because there was an recall, 1920 to 1921 saw a worldwide American, a French, and a British occu- and pans for money and using the depression. In the United States pation army there, and they were money to buy the potatoes. And so prices fell by nearly 50 percent from enforcing the price controls. So you Germany with a very much smaller 1920 to 1921. Germany was almost the had about as well-enforced price inflationary pressure had an enor- only country in the world to escape controls as you could imagine. The mously greater reduction in its that depression. While the rest of the result was that, because this inflation economic output. Indeed, the action world was having a decline in output, was suppressed, the prices were not taken in response to this episode is the Germany was booming. There was an allowed to find their own level, and reason Ludwig Erhard is chancellor of artificial kind of a boom that had output in Germany was cut in half. Germany today. great social costs, but from the purely Walter Eucken, a German economist, One Sunday in 1948, Erhard, who technical point of view, the inflation wrote a wonderful article on this was economics minister then, released did not prevent the economy from experience in which he tells the story an announcement that all price operating. of workers in a factory making alu- controls were abandoned. He did it After World War II, Germany minum pots and pans who would work on Sunday because that was the was again faced with an inflationary in that factory for three days a week. day on which the Allied offices of problem, but it was an inflationary They would receive their pay in the military occupation were closed and problem of enormously smaller form of some of the pots and pans they so they couldn’t contradict his order. scope. Prices rose about fourfold. had helped to produce. They would Immediately, there was a very sizable Now that seems like a big inflation spend the rest of the week scouring the rise in recorded prices, but immedi- and it is. For prices to go up to 400 countryside trying to find a farmer ately also the price system started percent of their initial value is a sub- who was willing to trade them some operating again. That was the source stantial price rise. But it is negligible potatoes for those pots and pans. of the German economic miracle, as it by comparison to what happened The problem is, if you don’t let came to be called, which produced a after World War I. Yet that rise was prices rise, you destroy the system tremendous increase in the total out- not permitted to happen openly after which organizes the economy, the put of Germany over the next year or World War II. There was widespread price system which coordinates the two. There was no mystery about it. price control. Under those circum- activities of different people. You It had nothing to do with the capacity stances, price control can almost force people into the inefficiency of of the German people for hard work never be enforced. From the time of barter, or a man producing pots and or with any special wisdom of the the Roman Empire to the present, pans trying to find a man who has American occupation authorities or you cannot in general enforce price potatoes, instead of selling the pots with any assistance from us to them. PHOTOGRAPHY: COURTESY OF MILTON FRIEDMAN

Summer 2005 • Region Focus 5 It solely was a case of substituting from copper producers at home. sequently to 90 cents. Of course, this an efficient money system for an The next step is to impose export brought a tremendous inflow of silver inefficient barter system. quotas on copper. Now if you want to into the U.S. Treasury just as our price The money system is so important export copper, you are prohibited from fixing in wheat did. We kept the price that if you prevent it from operating doing so unless you can get a permit of silver at the same level and in the efficiently something else will come from the Department of Commerce. meantime prices in general more than along. In the period This is inevitable. If doubled. Hence, a very high price from 1945 to 1948 you are going to fix became a very low price and now, in in Germany, as Wage and price the price of copper, order to prevent the price of silver you may recall, then you will have from rising above $1.30, we’ve had to substitute monies controls destroy the to decide who shall sell silver out of these stocks. We’ve developed. Ger- buy copper at that had a shortage and, as you know, we’ve mans started to system which organ- lower price, and so substituted Federal Reserve notes for use cigarettes as a izes the economy. it goes all down silver certificates, and sandwich coins form of money: cig- the line. for solid coins. So we know how to arettes for small We have so far produce shortages or surpluses. transactions and Cognac for big ones. in the United States had the most That’s what has been happening in That was when they really started talk- extensive experience with repressed the foreign exchange market. We’ve ing about the importance of having inflation in an area where it is been pegging the price of the dollar. adequate liquidity. And you may most destructive, namely, foreign The result has been a whole series of remember that there were stories in exchange. We have been pegging for direct interferences with individuals American newspapers of this time some years now the price of the and with trade. You know as individ- saying something like, “Look at these pound sterling in terms of the dollar, uals some of the minor irritants, crazy Germans. They just got beaten the price of francs in terms of the dol- things like the reduction of the duty- in the war and they are poor and lar, the price of gold in terms of the free allowance tourists can bring in. devastated. Yet they are willing to dollar, and so on. And we have had Much more important has been the pay $1.50 for a package of cigarettes. the usual consequences from price interest-equalization tax which has How silly can they be?” The answer, fixing. You know, economists may not established a differential exchange of course, is that they were no more know very much, but there’s one rate, a devalued exchange rate for silly than you are when you’re willing thing we know. We know how to pro- capital transactions. Also, there are to pay $10 for a piece of paper (a $10 duce either surpluses or shortages. oil import quotas, copper export bill) that’s only worth a penny as paper. You just tell us what you want. If you quotas, and I can’t begin to name the You don’t pay $10 for this piece of want to have a surplus, we’ll tell you host of specific quantitative controls paper in order to burn it or to write to set the price too high. Have a high that have been promoted by the notes on it. Neither were the Germans price on wheat and you’ll be sure attempt to peg exchange rates. paying $1.50 or $2 for a package of you’ll have wheat running out of your I mentioned foreign exchange cigarettes in order to smoke them. bins. If you want a shortage, we’ll tell pegging because that is a particularly That was money because prices in you to set a low price. Put rent con- important type. The example that terms of cigarettes were not con- trol on rental quarters in New York, comes to mind in this case as a trolled, and it developed as a very and you’ll be sure you will have a cautionary tale of where it can lead inefficient substitute money. shortage of dwelling units to rent at you to is India. India is a country The repressed inflation in that price. which has been having inflation over Germany was far more destructive of We’ve been doing pretty well in the the past decade or so, and it has been economic output and productivity case of silver with first creating a repressing it the way in which we than the open inflation after World surplus and then creating a shortage. have been trying to repress it here. War I. And this is true more generally. We’ve had it both ways in that case. The key in India is the exchange Let me come back to the United Incidentally, the story of silver is fasci- rate of the rupee. The official price States to see some parallels in very nating. In the 1930s, we had a silver of the rupee is 21 cents, 4.7 rupees to small ways. Not long ago, there was purchase program that, as it hap- the dollar. If the rupee was worth pressure on American copper produc- pened, was one of the main reasons 21 cents five or 10 years ago it is ers not to raise the price of copper. why China is communist today. I certainly not worth it now because The next step, of course, is that, since won’t go into that one right now, prices have gone up 30 or 40 or 50 copper is selling for a higher price except to note that under the silver percent. I’m not sure of the latest abroad than it is at home, everybody purchase program we raised the price figures. But India has tried to main- wants to export it and nobody wants of silver in one year from 25 cents an tain that exchange rate. The result is, to import it. People want to buy it ounce to 75 cents an ounce and sub- of course, that everybody wants to

6 Region Focus • Summer 2005 import and nobody wants to export. is to introduce enormous inefficien- nomic efficiency and from the point of So you then have quotas and exchange cies and to expand very greatly the view of the preservation of political permits on imports and subsidies on scope and extent of direct controls. freedom. If we are going to have exports. You have to ration imports This, in turn, has a further effect inflationary pressure we should have it of steel, copper, and so on. which is the final consequence I want open — let prices rise, let it go. Better The next stage is it becomes of to mention of trying to stop inflation yet, of course, would be to remove the great economic value to have an by holding down prices and wages. source of the inflationary pressure by import permit. Indeed, if you ask The effect is of a political character. slowing the rate of expansion of what has been the major source of We have had a number of episodes in money. new fortunes in the last 20 years in the past five or six years in which After the 1960 recession, itself the world, including the United there’s been an attempt to hold down largely produced by a sharp retard- States, there is no doubt it has been wages and prices. We had the ation in monetary growth, indeed an getting the ear of governmental offi- Kennedy confrontation with the steel absolute decline, the Federal Reserve cials to get special permits, whether industry in 1962. We had the more System did the right thing by increas- it be to have a single television recent episode with aluminum. The ing the rate of growth. They have also station or to have a permit to import interesting thing to me is the drastic done the right thing by maintaining a copper. In India this is very wide- change that occurred between the fairly high rate of monetary growth. spread. There’s enormous corruption first and the second episode in the This is the main source of our long and bribery involved in the exchange willingness of businesspeople who continued expansion. Unfortunately, permit system. Indeed, the major were potentially affected by it to however, they overdid a good thing obstacle to having a devaluation of speak out freely and express their sen- and expanded the quantity of money the rupee exchange rate or allowing timents about it. And I don’t blame at too high a rate. This has built into the rupee to go free is that there them. our society some pressures driving are now so many people who have There is no legal authority whatso- toward higher prices. We cannot elim- vested interests in the exchange rate ever whereby the president or any inate this pressure and stop the system because they have the import other official has the power to require inflation without paying a price. The licenses. the aluminum company or the steel danger is that if we try to do so, as we Exactly the same thing is true in company to hold down its prices or a sooner or later will have to, by curtail- this country. The permit to export union to hold down its wage rates. ing the growth of the quantity of copper is a valuable thing now. I There is no official authority, but money, that we will go too far, that we mentioned the TV and radio stations, there is lots of power lying around will overdo the reaction. Even if we and that’s a special example of the Washington. There are lots of extra- don’t overdo the reaction, there is no same kind of thing. Here you have legal pressures that can be brought way of bringing inflation to a halt sud- something that’s worth several mil- to bear. After all, there’s hardly a man denly. There is already built into the lions of dollars if you get it, and if you in the country who cannot now be economy forces for making price get it, you get it for nothing. Then subjected to great inconvenience by increases. people are surprised why there should having a tax official suddenly decide If you were to take the correct and always be charges of corruption and that his return needs extra careful proper measures, which is to slow bribery in connection with television scrutiny — and which return doesn’t? down gradually the rate of growth of and radio licenses. The threat of antitrust action is the quantity of money, there will for To come back to my main theme, not something which any business- a time be a continuation of inflation the effect of trying to hold down man is going to take lightly. There is a at the same time that we experience prices by suppressing individual wide range of governmental contracts some measure of recession and un- prices and wages is to eliminate the that are available. The attempt to hold employment. That is part of the price central governor of the economic sys- down particular wages and prices we are going to pay for having in the tem, the central method by which we produces a resort to extra-legal power, past three or four years stepped on organize our economic activity. If you which, in its turn, tends to spread and the accelerator too hard. But that will insist on doing that, you are going to to lead to a suppression of individual be far better and a far lower price than have to substitute something else. and personal and political freedom to continue along our present lines of You are going to have to engage in and to a great lessening of the willing- trying to conceal the inflationary rationing and indirect controls. You ness of people to dissent. These are pressure by appealing to the social are going to have to decide who shall some of the consequences of the responsibility of business leaders and buy from whom and how much. attempt to stop inflation by holding labor leaders, reinforced by an appeal The effect, therefore, of trying to down particular prices and wages. to unnamed and unspecified exercise stop inflation by holding down I think they are extremely serious of governmental power. individual prices and individual wages both from the point of view of eco- Thank you. RF

Summer 2005 • Region Focus 7 SHORTTAKES

SOLD! MOVING ON James River Islands GM Plant Closure Auctioned Frees Up Prime Parcel

n Feb. 22, close to 300 people t its peak, General Motors Opacked a Richmond auc- A Corp.’s van assembly plant tion house to bid on some very in southeast Baltimore employed unusual property: 39 islands scat- 7,000 workers. At the beginning tered across a short stretch of the of 2005 that number was down James River. to 1,100, and it dropped to zero Located in Goochland on May 13 when the automaker County, several miles up the river closed the plant for good. from Richmond, these islands But the blow of losing yet range in size from 5 acres to one- more Fifth District manufactur- hundredth of an acre. Potential ing jobs is somewhat blunted in buyers were informed that the this case. Economic developers acreage depends on the water view the closure as a rare oppor- level and that some of the islands tunity to create a new industrial are below water part of the year. park in one of the state’s prime Bidders were not thwarted by pieces of real estate. this news — or by the fact that News of the planned closure ownership of five of the islands A love of the outdoors and a desire to have their own last fall sparked a virtual cottage was contested at the time of the place to enjoy it drew about 300 people to the industry of proposals for what to auction. According to Tim February 2005 auction of 39 islands located on the do with the site. (The announce- Dudley, vice president of real Goochland County stretch of the James River. ment came well before June’s estate for Motley’s Real Estate report that GM planned to shed and Auction Group, all 39 islands were bid on, and the 25,000 workers from its payrolls over the next few years.) islands with contested ownership sold for approximately No wonder. It sits on 182 acres nearby the Port of $6,000 per island. Baltimore. Why would people be willing to buy up the islands, “There’s a lot of demand for how we redevelop this despite the iffy conditions? For most buyers, it was a love land,” says Aris Melissaratos, Maryland’s economic devel- of the great outdoors, to have their own place to camp, opment secretary. “The strategy for developing this land is fish, hunt, and enjoy watching wildlife. key to the future growth of the port.” “Many islands are now being claimed because of the A GM spokeswoman says the company continues land value and because land that might have been unim- to explore options. It can take more than a year to de- portant years ago has taken on a different perspective. commission plants like the one in Baltimore, which most They’re great as a recreational opportunity,” says George recently made GMC Safari and Chevy Astro minivans. Sydnor, the Richmond businessman who sold the islands at The plant closure came as little surprise to state the February auction. officials. The good news, Melissaratos says, is that 70 per- According to a recent survey from the U.S. Fish & cent of the GM workers were retirement-eligible. Wildlife Service, wildlife-related recreation is a $108 Melissaratos has backed Gov. Robert Ehrlich’s request billion industry nationwide, 12 percent of which is leasing that GM donate the property to the state and further or buying property for such recreation. asked that the company open a research and development Furthermore, an increase in outdoor recreational facility on the site. hobbies — combined with higher disposable incomes The secretary thinks up to 5,000 jobs can be created and lower interest rates — has played a role in creating on the site which would be called the Baltimore Global a niche market for recreational land. Trade and Technology Center and include GM’s R&D All of the islands sold on the day of the auction, but some unit, mid-rise office buildings, and port-oriented manufac- buyers decided not to go through with the deal. turing and distribution operations. Melissaratos thinks For example, one man who took his surveyor out to the river, groundbreaking for the new buildings should happen could not find “his” island and backed out. — JENNIFER SPARGER simultaneously with demolition of the van plant. PHOTOGRAPHY: DWIGHT DYKE, VIRGINIA DEPARTMENT OF GAME AND INLAND FISHERIES DEPARTMENT VIRGINIA DYKE, DWIGHT PHOTOGRAPHY:

8 Region Focus • Summer 2005 Despite the optimism, taking full advantage of the make Wal-Mart pay more for health insurance, they might abandoned site is a steep challenge. GM workers were simply lower other forms of compensation,” notes Yelowitz. paid an average of $27 an hour, and even in a market with Or companies could reduce the hours of part-timers to low unemployment, matching those wages may be a make them ineligible for benefits. In Hawaii, the only state stretch. Still, Melissaratos is undeterred. He sees the re- that mandates health coverage of employees, the percentage development of the site as part of a larger “transformation of people working 20 hours a week or less is higher than of Maryland’s old manufacturing economy to a new knowl- the national average due to businesses trying to skirt the edge economy.” — DOUG CAMPBELL mandate. — CHARLES GERENA

COVERING THE UNINSURED BACK BY POPULAR DEMAND Maryland Governor Vetoes Fifth District Utilities Seeking Permits “Anti-Business” Health Benefit Mandate for New Nuclear Capacity oncerned about the growing number of working t’s been almost 30 years since an American power CAmericans lacking health insurance or dependent on Icompany ordered a new nuclear power plant. Now, three Medicaid, Maryland lawmakers in April mandated that large groups of reactor makers and utilities, including major employers spend a minimum amount of money on health players from the Fifth District, are seeking to break that benefits. A month later, the law was vetoed by Gov. Robert drought. Ehrlich, Jr. as being anti-business. Ehrlich also vetoed a bill In the past, power companies had to apply for separate that would have increased the state’s minimum wage by a licenses to build and run a plant, each of which required dollar. extensive regulatory and public scrutiny. That’s why The Fair Share Health Care Fund Act would have Congress took several steps to streamline the licensing required companies with more than 10,000 employees to process in 1992, one of which was to create a single devote at least 8 percent of their payroll to health insurance, construction and operation license (COL). excluding wages paid in excess of the state median income. Despite this change, power companies didn’t rush out Alternatively, large firms would have to pay the difference to apply for a COL. Instead, they chose to upgrade their between their health insurance costs and 8 percent of total existing nuclear plants. wages into the state Medicaid fund. The reluctance to build nuclear plants has softened in the Four companies in Maryland have that many workers: last few years. Fossil-fuel prices have risen, electricity demand Giant Foods, Johns Hopkins University, Northrop has increased, and power companies have faced Grumman, and Wal-Mart. Only Wal-Mart would have had to pressure to reduce their emissions. These factors have put increase its spending on benefits, which is why the law was nuclear power back on the table along with other alternatives. widely regarded as targeting the mega-retailer. “We have to look at our customer needs and the most The law was aimed at low-skilled workers whose employ- economical way to meet them,” says Rita Sipe, spokes- ers often don’t provide comprehensive benefits packages woman at Charlotte-based Duke Energy. Duke belongs to and whose relatively low wages make it difficult for them to NuStart Energy Development, one of the three consortiums purchase insurance on their own. “Somebody still has to that applied for a COL in response to the U.S. Department empty the trash, park the cars in the garage, and landscape of Energy’s November 2003 solicitation. To provide an yards,” says Tom Hucker, executive director of Progressive incentive for companies to test the licensing process, the Maryland, which lobbied for the vetoed legislation. agency offered to cover up to half the cost of the process, Still, Maryland’s mandate for employer health benefits estimated at $400 million. wouldn’t have addressed why some salaries aren’t keeping up Filing a joint application helps spread out the financial with health costs. Also, it wouldn’t have helped many thou- burden and risks among the eight consortium members that sands of other workers who aren’t employed by large are power companies, including Duke, Baltimore-based companies. According to a December 2003 report by the Constellation Energy, Raleigh-based Progress Energy, and Kaiser Commission on Medicaid and the Uninsured, 49 per- EDF International North America in Washington, D.C. cent of uninsured workers nationwide are either Each company contributes $1 million to the consortium and self-employed or at firms with less than 25 people. will have an equal share in any new plant that is built using A proposal to cover a broader range of companies failed the COL. to pass the state’s General Assembly last year. “Lawmakers Marilyn Kray, president of NuStart, says the group is are very sensitive to small-business owners who are trying to evaluating potential plant sites and working with consortium create jobs,” explains Hucker. members General Electric and Westinghouse to have their Economist Aaron Yelowitz at the University of Kentucky reactor designs certified by the National Regulatory says it’s hard to know how much Maryland’s health benefit Commission. If all goes well, NuStart’s COL application mandates would have affected businesses, but he thinks that could be ready for submission within the next three years and they could have had unintended adverse effects. “If you construction could begin on a plant by 2010. — CHARLES GERENA

Summer 2005 • Region Focus 9 JARGONALERT Monopoly BY AARON STEELMAN

conomic terms don’t often find their way into everyday American companies to improve their products — to the parlance. There are a few exceptions, though. Consider benefit of everyone. This is the case of an oligopoly collaps- Ethe term “monopoly.” In a debate, for instance, you ing, as consumer sentiment shifted and barriers to entry — might hear one person tell the other that “no one has a monop- such as import restrictions — became less burdensome. oly on the truth.” What the person means is that there isn’t just But what if an oligopoly doesn’t collapse? How dangerous one side to an issue — there are two or maybe even more. is it? The late George Stigler, whose work on industrial organ- In economics, the term “monopoly” is used in a similar ization won him the Nobel Prize in economics in 1982, long way. When there is only one seller of a good or service, that favored antitrust laws aimed to break up oligopolies, but over company is dubbed a monopoly. time lost his “enthusiasm for antitrust policy and much of Economists object to monopolies because they can our fear of oligopolies.” lower social welfare. The reason is that the monopolist can Antitrust laws, Stigler believed, were actually being used raise the price of its good or service above the by some companies to prevent competition rather than to competitive level, to a point where consumers demand less increase it. And in other cases, they were a barrier to poten- of the product than they would otherwise. tially useful mergers. Consider the case of a monopolist widget In addition, empirical analysis led maker. He can produce widgets at a con- Stigler to believe that oligopolies often stant cost of $2 per unit. If he charges $3 were unable to earn returns much for the good, he can sell 600 units, while if above what we would expect in a com- he charges $4, he can sell only 400. You petitive market. “The relationship might initially think that he would choose between profitability and concentration to charge $3 so that he could sell more is almost invariably loose: less than widgets. But charging $4 is actually more 25 percent of the variation in profit profitable. Under that scenario, he makes a rates across industries can be attributed profit of $800 (400 x $2). At $3 per widget, to concentration,” Stigler wrote. his profit is just $600 (600 x $1). From the Why might this be the case? There point of view of the widget maker, produc- are several possibilities. One is that ing fewer widgets is the rational thing to cartels are inherently unstable. A small do. But society is made worse off. If the number of firms may collude to raise market were competitive, more widgets prices. But there is always an incentive would be produced and consumed. for one of those firms to defect, lower its Similar problems can arise in the case price, and gain the lion’s share of the of an “oligopoly.” This is when a market is market for itself. Another reason is that dominated by a small number of firms. If the mere threat of a startup company those firms decide to coordinate their actions entering the market and taking business and raise prices above a competitive rate — thus forming a away from existing companies can exert discipline on “cartel” — the oligopolists in effect act like monopolists. monopolists and oligopolists, making them behave as if com- How common are monopolies and oligopolies in the real petition were brisk. world? And do they typically lower social welfare in the Some monopolists and oligopolists, however, enjoy way described above? government protections that shield them from such compe- Some industries have been dominated by only a few firms. tition. The taxi industry is one example. In many cities, the Take the auto industry, for example. From the 1950s through number of cabs in operation is tightly controlled by local the mid-1970s, the “Big Three” automakers — General officials. The U.S. Postal Service is another. Companies like Motors, Ford, and Chrysler — dominated the U.S. auto mar- FedEx can compete on the shipment of packages, but with ket. During that period, they regularly produced about 90 a few exceptions cannot deliver letters. percent of all vehicles purchased domestically. Now, however, In theory, it’s easy to see why monopolies and oligopolies that figure is down to about 58 percent. could be socially undesirable. In practice, though, the Many Americans were unhappy with the choices offered evidence is not so clear, and the actions used to prevent by Detroit, and turned instead to cars from foreign auto- industries from becoming concentrated sometimes can makers. Ultimately, competition from abroad forced the produce effects worse than the problem itself. RF ILLUSTRATION: TIMOTHY COOK

10 Region Focus • Summer 2005 RESEARCHSPOTLIGHT Why Regulations Fail — Yet Persist BY AARON STEELMAN

egulations often do not achieve their intended to the commercial forests of North Carolina. Owners of effects. In fact, sometimes they produce results forests where the red-cockaded woodpecker lives are Rcounter to their goals. Why? forbidden to remove trees in those forests. But, of course, In a lecture delivered at the AEI-Brookings Joint Center woodpeckers fly around and establish nests in nearby for Regulatory Studies in September 2004 and later re- forests. If you own a nearby forest, “your incentive is very printed in monograph form, economist Sam Peltzman of clear — cut down all those trees now! If you wait and the University of Chicago argues that regulations fail when your land becomes habitat for this species, your lumber they create incentives for “offsetting behavior” — actions will be lost.” This is not good for the birds. Nor is it good that negate some or all of the regulations’ desired effects. for the owner of the forest, who might have preferred Peltzman offers three examples of offsetting behavior to allow the trees to grow larger before removing them. undermining a regulation’s effectiveness. The first is auto So if such regulations fail to meet their objectives, why safety, an area in which he has written some influential — do they persist? In some cases, regulations benefit a and controversial — papers. The National Traffic and relatively small group of people who lobby for their Motor Vehicle Safety Act of 1966 mandated the installation survival. Consider the ADA. It may harm people with of seatbelts, collapsible steering columns, and pop-out disabilities who are looking for jobs, while helping disabled windshields. Such devices should make the roads safer, people who are already employed. The latter obtain “better right? Yes, if their presence did not alter the behavior of working conditions, no lower pay, and an option on a future drivers. But Peltzman argued antidiscrimination complaint that the safety devices effec- to the Equal Employment tively lowered the cost of “Regulation and the Natural Progress Opportunity Commission,” driving dangerously, since driv- Peltzman writes. “The benefi- ers would be better protected of Opulence” by Sam Peltzman. ciaries know who they are. in the case of an accident. His The victims … often do not.” prediction has been largely AEI-Brookings Joint Center for This explanation is con- supported by subsequent sistent with many other case empirical work. “The actual Regulatory Studies, September 2004. studies of the political economy effect of the safety regulation of regulation. But Peltzman on the death rate is substan- argues that a more powerful tially less than it would be if real people behaved like crash force is at work. The enormous progress characteristic of dummies,” he writes. a society with a well-functioning economy can hide the A second example involves the Americans with failures of regulation. “As long as the thing being regulated Disabilities Act (ADA). The ADA, he argues, has actually is seen to be working tolerably well — and that will often reduced employment opportunities for people with be the case in a growing economy — then the regulation is disabilities. The logic is as follows. Prior to the ADA, safe politically,” writes Peltzman. employers could hire people with disabilities and observe If correct, does Peltzman’s argument render economic whether their value to the company exceeded their wages analysis irrelevant to policy discussions? After all, if the plus any special costs of accommodating them in the work- public sees only what is before them and not how life might place. If it did, they would be retained. If not, they would be be different, and perhaps even better, in the absence of let go. But now employers are wary of taking a chance on regulation — the type of thing that economic analysis tries hiring someone with a disability because companies who to do — they are unlikely to push for change. terminate a disabled worker are potentially subject to large Peltzman is cautiously optimistic. “It may be true that penalties for employment discrimination. Of course, the economic analysis cannot all by itself change a well- companies may also be subject to penalties for not hiring entrenched mode of regulation. But economic analysis does the disabled worker in the first place, but Peltzman argues often, I believe, play an important catalytic role when regu- that such discrimination cases are harder to prove. latory issues become politically salient.” In other words, Peltzman’s third example has a Fifth District connec- when a regulation’s failures become manifestly obvious — tion. The Endangered Species Act of 1973 is designed to as was the case with the regulation of the transportation protect animals on verge of extinction and their habitats. industry in the 1970s — economic analysis can bolster One such animal is the red-cockaded woodpecker, native the case for revising or repealing that regulation. RF

Summer 2005 • Region Focus 11 POLICY UPDATE Freer Trade in Textiles Changes Import Sources BY BETTY JOYCE NASH

he end of textile quotas in the United States Textile industries in the United States have difficulty is rearranging textile production worldwide. competing with countries where production costs are TThe set of quotas known as the Multifiber Arrange- cheaper. Labor-intensive production moves from country to ment (MFA), aimed to keep domestic manufacturers from country. The garment industry gives poor countries being overrun with competition, expired at the end of 2004. a leg up in the quest for industrialization. The total level of imports hasn’t risen dramatically as a result, “What does a textile industry do for a country?” asks but the sources of the goods have been sharply affected. Brasher, who has helped establish textile manufacturing in Total U.S. imports of textile and apparel rose 6 percent in Bangladesh and other developing countries. A lot, he says. March compared to the same month in 2004. But imports Just consider the case of Manchester, England, a city that from China, India, and Bangladesh rose by about 43, 31, grew dramatically in the 18th and 19th centuries as textile and 45 percent, respectively. Meanwhile, imports from production boomed there, and is now considered one of Mexico, Hong Kong, South Korea, and Taiwan fell sharply. the birthplaces of the Industrial Revolution. March is the first month from which meaningful data Many observers fear that the textile industries in poor can be drawn, since it’s the first truly countries can’t compete with China. quota-free month, according to Donald Textile/Apparel Tally* Fifth District textile firms are continu- Brasher of Global Trade Information ing to shut plants. Springs Industries, Services, Inc., a trade statistics company. Overall 6% based in Fort Mill, S.C., has closed six He explains that the January and February China 43% since last year. WestPoint Stevens’ most trade data included goods shipped in late India 31% recent cuts include 1,905 jobs in North 2004, under the quota regime. Bangladesh 45% Carolina, and VF Corp. is closing its The U.S. Department of Commerce Mexico -11% Wilson, N.C., jeans plant in 2006, putting responded in May to heavy Chinese Hong Kong -30% 445 people out of work. National Textiles imports in some categories by placing S. Korea -20% shut its Greenwood County, S.C., plant “safeguards” on certain textiles from China, Taiwan -18% in June, costing 390 jobs. including cotton pants, shirts, and yarn. *Textile and Apparel Imports, March 2005 Some of the closings can be attributed It won’t help domestic producers, over March 2004 to disappearing protections. But the Brasher says. “It is a total nonissue; it’ll SOURCE: Global Trade Information Services, Inc. quotas didn’t save the domestic textile only come in from other countries,” he industry, notes Edward Gresser, director predicts. of the Progressive Policy Institute’s Project on Trade and The fear of Chinese imports flooding the U.S. market is Global Markets. only the latest in a long line of import threats. The United “If you look at the quota system — it became effective States restricted Japanese textile imports after that country in 1974 — at that time there were about 2.5 million people became the world’s largest textile exporter in the 1930s. working in textile and apparel” in the United States, says By 1960, the United States had limited imports from Gresser. “Now there are half a million. It really wasn’t Hong Kong, Pakistan, and India, too. Twelve years later, very good at keeping jobs anyway.” the United States had agreements with 30 countries, and By shedding workers, textile firms in the Fifth District by 1994, 40 countries were affected, according to the hope to stay competitive. “It has been more intense than Economic Research Service of the U.S. Department of even our worst calculations,” says Ted Matthews, Springs Agriculture. As imports were restrained from one country, Industries’ spokesman. He attributes the most recent six plant production moved elsewhere. closings directly to the quota-free environment. Springs Pietra Rivoli, an economist at Georgetown University Industries is a 118-year-old, privately held textile company. and author of Travels of a T-Shirt in the Global Economy, argues With vast new capacity worldwide, customers demand that the MFA hastened globalization. rock-bottom prices. World prices for the firm’s key product “Each time a hole in the import dike was plugged by lines, sheets and towels, have plummeted. “Admittedly, quotas — on cotton socks from China, say, or silk ties [Springs] will have a much smaller number of facilities than from Thailand — the effect was not to preserve U.S. jobs, we have had historically,” Matthews says. but instead to increase the force of imports gushing in While quotas may have delayed some job losses they’ve from other countries and categories,” she wrote recently in increased prices by 5 percent to 10 percent, according to YaleGlobal, an online magazine. the Economic Research Service. RF

12 Region Focus • Summer 2005 lightslightsout

Three years after the enactment of the Sarbanes-Oxley Act, questions are mounting about unintended consequences for hundreds of U.S. firms

BY DOUG CAMPBELL

Squeezable lightbulbs with the Enron logo were just one of a warehouse full of items auctioned off after the company’s demise in 2001.

n March 17, shares in discount S&K officers said they wouldn’t have tion — that is, everything from the men’s clothier S&K Famous done it if not for the Sarbanes-Oxley sale of a $20 necktie to the return of a OBrands fell 8.6 percent. Act of 2002. A press release summed it $500 suit, how they are keyed in, and Executives at the Richmond-based up this way: “The increasing financial how they are stored in the warehouse. firm were hardly surprised. In fact, cost and commitment of manage- These are already well-documented Chief Financial Officer Robert ment’s time to regulatory compliance procedures at S&K, but reporting Knowles had thought the dive might have become a burden that will only under the new rules would bring be steeper. increase over time.” about, for one thing, the hiring of a The day before, S&K had Knowles estimates his firm can second auditor to conduct its own announced that it was terminating its save $300,000 a year by sidestepping review of S&K’s internal operations. registration under the Securities and just a single component of Sarbanes- Knowles frowns in explaining it all. Exchange Act of 1934. In market slang, Oxley, Section 404, which requires a “It’s not a necessary procedure for us,” S&K was “going dark.” No longer detailed, independent review of a he says. “The shareholder isn’t going would the company file quarterly and company’s internal financial reporting to get anything more out of Section annual reports on its financial condi- controls — plus a signed declaration 404 — other than the fact that we tion, and so no longer was the ticker from top executives and auditors that spent $300,000.” symbol SKFB welcome on the Nasdaq those controls actually work. For S&K’s management is far from National Market. S&K shares would S&K, such a review is a budget-buster. alone in this sentiment. Corporate instead trade on the Pink Sheets, land Among other things, compliance America has a new scourge: Sarbanes- of the penny stocks, where Securities would mean documenting how a large Oxley. High-profile critics include the and Exchange Commission noncom- sample of S&K’s 240 stores in 27 U.S. Chamber of Commerce and the pliance is no barrier to membership. states report each and every transac- Wall Street Journal editorial page. PHOTOGRAPHY: AP/WIDE WORLD PHOTOS WORLD AP/WIDE PHOTOGRAPHY:

Summer 2005 • Region Focus 13 Citing the new rules, a growing num- A broad spectrum of analysts and Act of 1934, which created the SEC ber of firms since 2002 have either observers agree that portions of as the centerpiece of an effort to pre- stopped making filings with the SEC Sarbanes-Oxley — chiefly, the notori- vent a repeat of the 1929 market crash. or gone private. (Unlike “dark” firms, ous Section 404 of the act — provide With the go-go 1990s a fond companies that go private stop trad- few direct benefits to investors and memory, politicians responded to ing to public investors and usually, but even fewer to the companies trying public clamoring for a corporate not always, repurchase all of their to implement them. Even after crackdown, something to dissuade outstanding stock.) This was not Sarbanes-Oxley, internal controls future Enrons from happening. They exactly what lawmakers had in mind were responsible for detecting fewer produced a set of rules whose main financial frauds than those detected provisions aimed to hold CEOs and by tips, internal audits, and “by acci- CFOs more accountable for their SARBANES-OXLEY dent,” according to a 2004 survey firms’ financial disclosures, required ACT OF 2002 by the Association of Certified Fraud more thorough reporting programs, Examiners. Meanwhile, critics say and established stricter standards for To protect investors by improving the accuracy and relia- Sarbanes-Oxley amounts to a gift to membership on board audit commit- bility of corporate disclosures made pursuant to the the accounting industry, requiring as tees. There also was the creation of a securities laws, and for other purposes. it does extra auditors and accountants. new oversight board to monitor the But a closer look at the studies and accounting industry. Underlining all of SEC. 404. MANAGEMENT ASSESSMENT OF the firms going private or dark is it were hefty doses of new criminal INTERNAL CONTROLS. revealing. First of all, this involves only penalties — fines of $5 million and a tiny fraction of companies that trade 20 years in prison for executives who (a) RULES REQUIRED. The Commission shall prescribe in the U.S. public markets. Despite all knowingly certify false financial rules requiring each annual report required by section the chest-pounding over rising compli- reports. (Richard Scrushy, the first 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 ance costs, a large majority of the CEO to be prosecuted under U.S.C. 78m or 78o(d)) to contain an internal control approximately 17,000 publicly traded Sarbanes-Oxley, was acquitted June 28 report, which shall U.S. firms remain under the auspices of after three weeks of deliberation.) (1) state the responsibility of management for establish- the SEC. What’s more, for many, get- The reforms came at a time when ing and maintaining an adequate internal control structure ting out of the SEC’s view might have the country was coming out of re- and procedures for financial reporting; and been a prudent move even without cession and less than a year removed (2) contain an assessment, as of the end of the most Sarbanes-Oxley. These are generally from the terrorist attacks of Sept. 11, recent fiscal year of the issuer, of the effectiveness of the small firms that were already on the 2001. At the same time, stock ex- internal control structure and procedures of the issuer public-private margin — and that may changes were toughening their rules for financial reporting. even go for S&K Famous Brands. for listing, civil lawsuits were mount- (b) INTERNAL CONTROL EVALUATION AND REPORTING. Conflicting evidence like this ing, and the criminal justice system With respect to the internal control assessment required makes it difficult to assess the effects was stepping up, as perp walks featur- by subsection (a), each registered public accounting firm of Sarbanes-Oxley, especially on small ing former Wall Street darlings that prepares or issues the audit report for the issuer shall firms. It is entirely plausible that became commonplace. attest to, and report on, the assessment made by the many large corporate frauds have To some economists, Sarbanes- management of the issuer. An attestation made under been prevented because of Sarbanes- Oxley was an unnecessary pile-on. this subsection shall be made in accordance with stan- Oxley. Such deterrence would have a Disclosure is often in the best inter- dards for attestation engagements issued or adopted by significant and positive impact on the ests of businesses, since firms that the Board. Any such attestation shall not be the subject economy. The problem is that it is fully disclose their information may of a separate engagement. very hard to measure this possibility. command higher share prices for their Three years, it seems, has not been stock. Disclosure, many academics enough time to figure out whether agree, potentially reduces the age-old as a remedy to corporate scandals like Sarbanes-Oxley went too far. agency problem inherent in large Enron and WorldCom. organizations whose owners are not A new crop of studies lends some In the Wake of the Crash necessarily the same as their man- support to the claim that Sarbanes- Sarbanes-Oxley took effect under the agers. In this way, shareholders are Oxley may be having the unintended banner “Public Accounting Reform better equipped to keep an eye on effect of driving firms, especially and Investor Protection Act” when managers, making sure they are doing small ones, from the SEC’s watch. President Bush signed it into law on what they were hired to do: increase These findings are in keeping with July 30, 2002. It was universally regarded the firm’s share value. standard economic theory that exces- as the most substantial overhaul of Disclosure also takes the edge off sive regulation is bad for business — U.S. business regulations since the of adverse selection in capital markets and the wider economy as well. enactment of the Securities Exchange — if all investors are equally and well-

14 Region Focus • Summer 2005 The SOX Spike Two studies have attributed an increase in the informed, then fewer will buy shares in operations. Second, firms that “go number of firms going dark and going private to firms that ought to be avoided. But in dark” may happen to be the very sort of the July 2002 enactment of Sarbanes-Oxley. Sarbanes-Oxley, the government was financially stressed organizations essentially saying that new measures which shareholders might want closer 250 were necessary to reel in agency costs. tabs on — the very sort of companies Going Dark 200 Whether Sarbanes-Oxley has actu- Sarbanes-Oxley was designed to police. Going Private IRMS ally succeeded in easing the agency (A counter argument is that a F 150 problem remains up for grabs. “dark” Enron would never have been Disclosure does not automatically rid able to raise as much capital as it did; 100 UMBER OF N the world of fraud. Companies could in this way, the trend of troubled 50 meet all of the law’s disclosure require- firms going dark may not be such a 0 ments but still file fraudulent reports. bad thing because shareholders 1998 1999 2000 2001 2002 2003 2004 In addition, an economically rational wouldn’t be funding the new capital Sarbanes-Oxley enacted July 30, 2002 world seeks to “keep on spending on by buying up stock.) fraud prevention until the returns on a Going dark is probably the NOTE: Engel, Hayes, and Wang provide data for going-private dollar invested in prevention are no most extreme reaction to climbing firms through 2003 only. SOURCES: Leuz, Triantis, and Wang (2004) and Engel, Hayes, and more than a dollar,” says William compliance costs. Among the main Wang (2004) Carney, a law professor at Emory requirements for being able to University who is studying the costs of deregister is having fewer than 300 being public after Sarbanes-Oxley. In (sometimes 500) shareholders of further. “In the back of our minds was other words, wiping out all fraud would record. It can be a quick process. When that maybe Sarbanes-Oxley was be prohibitively expensive. You don’t S&K delisted, for example, it needed responsible for this,” says Alexander want it to cost more to prevent fraud only to provide written notice to Triantis, a University of Maryland busi- than the fraud itself would have cost in Nasdaq of its intent to delist and ness professor and co-author of the the first place. Better, Carney says, is to then file a Form 15 with the SEC. With paper “Why Do Firms Go Dark?” strive for an “optimal amount of fraud.” that, all obligations to operate under Just as they suspected, the authors And he is very skeptical that Sarbanes- the auspices of the SEC ceased and found that the number of firms that Oxley has brought us anywhere closer S&K — or any other deregistering went dark surged sharply after the to achieving optimization. Sarbanes- organization — could join the Pink enactment of Sarbanes-Oxley: from 43 Oxley, Carney writes, “may have Sheets, an automated quotation service in 2001, to 67 in 2002, and then way up reached the point where the costs of known informally as an over-the-count- to 198 in 2003 (see table). Because figur- regulation clearly exceed its benefits for er bulletin board. This is the land of ing out who’s going dark requires many corporations.” no-name stocks, firms which are combing through SEC filings, 2004 Numerous surveys have tried to longest-shot candidates to grace the numbers were still being tallied this nail down the new costs of complying covers of Fortune and Forbes. Inevitably, spring, but the researchers estimate that with Sarbanes-Oxley. Foley & Lardner, firms that go dark see their stock prices 134 companies delisted in 2004, still far a Chicago law firm, found in 2003 and fall, a function of both the Pink Sheets’ above the pre-Sarbanes-Oxley pace. 2004 that the average cost of being looser listing requirements and the rela- An examination of going-dark public for firms with annual revenues tive lack of liquidity compared with the filings among firms with headquarters less than $1 billion grew $1.6 million, Nasdaq or New York Stock Exchange. in the Fifth District is inconclusive, or 130 percent, since Sarbanes-Oxley People started to notice a spike in mainly because of the small sample took effect. In a different survey of “going dark” maneuvers shortly after size. In 2001, six Fifth District firms larger firms, Financial Executives Sarbanes-Oxley went into effect. In the filed to go dark; in 2002 it was down International reported that Section summer of 2003, some institutional to four but in 2003 the number 404 compliance clocked in at an aver- investors filed a petition arguing that jumped to 10. The pace slowed to six age $4.36 million per firm, which was many firms going dark were unfairly going-dark filings in 2004. In a fairly 39 percent higher than surveyed firms taking advantage of the 300-share- typical announcement just before its had originally expected to pay. holder rule. It was alleged that many of 2003 deregistration, Maryland-based If rising costs persuade large num- these firms actually had thousands of International Dispensing Corp. said it bers of firms to exit the public markets shareholders, but because their stock expected to save up to $190,000 a to evade SEC regulation, two distinct was held by a relatively small number of year: “The company believes that problems are created. First, the overall brokerages and other institutions, the the cost savings of terminating economy might suffer insofar as firms delisting firms could point to less than reporting obligations far outweigh the may give up investment projects 300 holders of record. Three business benefits of maintaining the company’s because they may have to rely on high- school researchers took notice of the status as a Securities and Exchange er-cost sources of capital to fund petition and decided to investigate Commission reporting company.”

Summer 2005 • Region Focus 15 Triantis describes the national exactly No. 200. At the time, despite S&K opted to remove those per- delisting trend as “consistent with a the business-casual trend of dress, it ceived extra seatbelts. The choice Sarbanes-Oxley effect but not com- was coming off five years of strong prompted the aforementioned stock pletely conclusive.” Firms may be profit and sales growth. Then in early drop, but has had little other negative going dark for completely sensible, 2004, it retired almost all of its debt, impact, Knowles says. The Pink above-board reasons — that is, the making for a healthy balance sheet. Sheets provide an adequate trading benefits of SEC listing are now But for all the growth, the market ground for S&K stock. And S&K swamped by the costs due to Sarbanes- was no longer rewarding S&K as will continue posting its financial Oxley. Most firms that go dark are before. S&K’s book value — essential- results on its Web site, still have described in their paper as distressed ly, what it would be worth if it sold off everything audited, and look to con- and small. By delisting, even factoring all its assets — was $20 a share, higher tinue its growth strategy and reward in the usual 10 percent stock price dip, by several dollars than the typical trad- shareholders. The only difference, firms are making an economically ing price in 2003 and 2004. Two years Knowles insists, is that S&K won’t be rational choice that may benefit share- ago, the last two analysts covering following Section 404. “The job is holders over the long term. S&K stock dropped their coverage, basically the same,” he says, referring The more negative interpretation leaving investors with fewer options to his post as chief financial officer. has it that the firms’ managers are for independent scrutiny of the com- Meanwhile, S&K’s stock was trading thinking more about their own inter- pany’s earnings prospects. Trades of about $17 a share going into the sum- ests than that of other shareholders. S&K stock grew rarer and rarer, mak- mer, close to its pre-Pink Sheets price. They want to protect themselves ing it more difficult for owners to sell All things considered, not bad for a from liability, and to continue using at a profit. With a market capitaliza- dark company. their companies as their own private tion of less than $50 million, S&K was piggy banks, keeping their jobs and known as a small-cap stock, barely a A Little Privacy increasing their compensation. blip on Wall Street’s radar screen. Going dark is not to be confused with “We think Sarbanes-Oxley definite- Then came Sarbanes-Oxley. At going private. A “dark” firm still trades ly has to be driving some of this,” first, S&K’s Knowles was optimistic. among outside investors. A firm that Triantis says. “Whether that’s simply He thought firms like S&K, with no goes private keeps its stock closely due to the cost of Section 404 that all history of governance problems and held. A public company can become these firms are complaining about or decent growth prospects, would see private in several ways, with the most whether it’s the increased scrutiny and their stock prices climb along with a common methods being a merger liability that managers want to avoid — boost in investor confidence. His with a shell company, a tender offer to that’s a little harder to determine.” mood turned sour when the implica- purchase shares from other stock- tions of Section 404 became clear. holders, or a reverse stock split that From High Flyer to Low Profile S&K was caught in the unfortunate reduces the number of shareholders S&K is a virtual case study of the position of being both small in terms of record to less than 300. In general, going-dark decision. Here is a compa- of financial resources but big in terms it’s a bit harder to go private than ny with an almost mythical-sounding of the breadth of work needed to com- dark, and sometimes requires a lot beginning. As told on the S&K Web ply with Sarbanes-Oxley. Section 404 more money. site, the company opened in 1967 mandates a thorough, independent A growing literature posits that when founder Hip Siegel loaded up his review of a firm’s internal financial many small and midsize firms ought station wagon with discounted suits reporting practices. For S&K, the to consider abandoning the public from department stores, then resold manpower and the costs involved in markets. Skyrocketing compliance them at a profit. The operation grew compliance were overwhelming. “We costs are only one part of the puzzle. to 10 stores by 1983, the year it first have cookie-cutter stores, 240 differ- These days, smaller public firms offered shares to the public. With the ent sites, over 1 million square feet in experience serious liquidity issues money raised, S&K immediately 27 states,” Knowles says. “Yet we anyway, trading with nothing like the doubled in size and kept a consistent would have to document all that from regularity and smoothness of S&P growth pattern through the early 21st a representative sample of all those 500 firms. This reduces the presumed century, today peaking at 240 stores. stores and have people who don’t advantage public companies have in Stuart Siegel, Hip’s son, soon took know menswear from a tree go in selling stock quickly and easily. over as chairman. He is a well-known there and try to document and then Besides ditching the costly trap- figure in Richmond, a philanthropist audit it. And what benefit can possibly pings of Sarbanes-Oxley, private whose home was recently featured in come from that?” companies get to keep more of their the local newspaper. Only four years Knowles adds with exasperation, financial information out of reach ago S&K cracked Forbes’ list of “200 “It’s like putting on three or four extra from competitors. Additionally, pri- Best Small Companies,” landing at seatbelts.” vate sources of capital — though

16 Region Focus • Summer 2005 generally more expensive than odd-lot tender offer that brought its public sources — are growing, number of shareholders to 278, which means that being private is a spending about $175,000 to pur- less significant barrier to expan- chase the stock of people owning sion than before. less than 100 shares. More intangible but with a Darlington Bank wasn’t even potentially greater payoff is the listed on a stock exchange to begin effect going private has on agency with. If a shareholder wanted to costs. Suddenly, the interests of sell some stock, bank management managers and owners are aligned would put them in touch with a more than ever in a private structure. Darlington County Bancshares, one of the potential buyer, and vice versa, refer- Instead of gunning for short-term smallest banks in South Carolina, saw its ring to a list kept at the bank’s only stock price struggle for years before direc- gains that might in the long run hurt office. But since it used to have more tors decided to go private. shareholders (e.g. Enron,WorldCom), than 300 shareholders, Darlington did managers of private firms are free testing company, served up one of have to file the usual 10Ks and 10Qs to pursue whatever is best for the 2003’s biggest going-private transac- with the SEC. After Sarbanes-Oxley, company. (Going private is not neces- tions when a group led by the firm’s that meant spending money on a new sarily a new trend; the reduction of chairman bought it out for about auditor to review controls that were agency costs was one of the reasons $1.7 billion. The complaint voiced already reviewed by multiple bank behind the leveraged-buyout craze of in a Wilmington, N.C.-based Reeds officers and regulators. the 1980s, a movement led by players Jewelers Inc. announcement in early Banks are unlikely suspects for like Kohlberg Kravis Roberts.) 2004 was representative of the going- stepped-up regulation. “The irony is Joseph Fuller, CEO of consulting firm private mood: “Operating as a that these institutions were already Monitor Group, wrote in a 2004 privately held entity will enable Reeds highly regulated, with records scruti- article that obituaries for the public to reduce certain costs related to being nized by government officials as well company structure may be a bit pre- a public company, including, among as their own auditors,” says law mature. “Still,” he added, “the form others, legal compliance costs.” professor Carney in his paper “The is showing its age and vulnerability.” As with going-dark firms, a theme Costs of Being Public After Sarbanes- Sarbanes-Oxley has brought that with the recent spate of going-private Oxley.” All that work reporting to observation into clear focus: Firms firms is their size: They’re small. After banking regulators is, unfortunately, are going private at a faster clip in the enactment of Sarbanes-Oxley, the not entirely transferable to SEC the wake of the new law. In a 2004 average size (by annual sales) of firms reporting requirements; everything paper, three University of Chicago going private was $74 million. And must be documented consistent with researchers added up 93 firms that that was less than half the size of the Section 404’s unique standards. filed to go private in the 19 months typical firm going private before the Referring to a finding that 15 percent before Sarbanes-Oxley was enacted new law, when the average was of all going-private filers in 2004 were and 142 going private in the 19 months $170 million in annual sales. (For banks, Carney says: “Surely investors after (see table). Rachel Hayes, an comparison, consider that cracking and depositors in these communities accounting professor and co-author of the Fortune 500 requires at least will not feel better off because of these the study, described that as a “modest $3.6 billion in annual sales.) developments … Say good-bye to the increase.” Hayes says it’s possible that Although Hayes is comfortable not- community bank that was owned by the increase is partly cyclical in nature, ing the modest increase in going-private the community.” but that her study mostly seems to transactions since Sarbanes-Oxley, she is Even though it’s now private, point to a combination of market not so certain about drawing larger con- Funderburk’s organization remains conditions and the effect of Sarbanes- clusions. “It’s so hard for us to look at subject to heavy regulatory scrutiny, Oxley as making “going private more our data and say these guys would not since it’s a bank. “We still have to com- attractive.” have gone private otherwise,” she says. ply with everything,” he says. “We just A Fifth District examination of “It’s very possible a lot of these would don’t have to do the reporting.” And going-private transactions is, as with have gone private anyway.” because of that, the bank figures to the going-dark case, inconclusive save $100,000 a year in auditor fees. because of the small sample size. There Never a Darling That is a lot of money for were seven going-private filings among Henry Funderburk is candid about the Darlington Bank, whose 2004 net Fifth District firms in 2001, four in very real possibility that his bank might income was just $343,000. 2002, a small jump to seven in 2003, have gone private anyway. Darlington Funderburk says Sarbanes-Oxley and then six in 2004. North Carolina’s County Bancshares, one of the smallest “gave us a final push” but admits Quintiles Transnational Corp., a drug- banks in South Carolina, executed an that going private was something the PHOTOGRAPHY:DARLINGTON COUNTY BANK COUNTY PHOTOGRAPHY:DARLINGTON

Summer 2005 • Region Focus 17 bank’s directors had been considering A SOX for Small Firms? difficult. Perhaps it did have the for years, anyway. Not even listed on a Overwhelmed with complaints about effect of restoring investor confi- stock exchange, what sort of benefits Section 404, the SEC has taken dence in the markets, but then again was Darlington reaping from being notice. This spring, the commission what about the role of the criminal public? for the third time extended the dead- justice system, which responded As it happens, that’s the same ques- line for smaller public firms to comply more aggressively than Litan had tion directors at S&K Famous Brands with Section 404. And there is grow- expected? Or the clamping down of had been asking themselves for some ing support, even among some the New York and Nasdaq stock time. Karen Newman, an S&K direc- lawmakers, for softening Sarbanes- exchanges, beefing up requirements tor and former dean of the business Oxley rules when it comes to small for membership? Or mounting civil school at University of Richmond, says companies. lawsuits against alleged wayward that when she took her seat on the For the few hundred firms that go executives? “You could argue that the board in the spring of 2004, discus- dark to evade investor scrutiny, deterrent effect of [those things] sions were already happening about “Sarbanes-Oxley has certainly not alone could have accomplished all the how to deal with S&K’s lifeless share served investors,” says Triantis, the benefits being claimed to Sarbanes- price. Sarbanes-Oxley, Newman says, University of Maryland professor. But Oxley,” Litan says. “Much of this was “the straw that broke the camel’s he is not rushing to entirely dismiss might have happened without back.” Sarbanes-Oxley as ineffective. Despite Sarbanes-Oxley.” Whether going dark is merely a the backlash, most firms are not Sarbanes-Oxley is, of course, named stepping stone to going private or a straying from the public markets or after its sponsors: Sen. Paul Sarbanes, a way station before returning to SEC going dark. Maryland Democrat, and Rep. Michael supervision depends as much on eco- Triantis says there are “hundreds Oxley, an Ohio Republican. Many nomic conditions as it does on of firms that could deregister that analysts and observers credit the pair’s Sarbanes-Oxley. CFO Knowles says don’t and many more that have 300 or legislation with a renewed emphasis that returning to the Nasdaq might more shareholders that could get on good corporate governance that very well be in S&K’s future. below that, so we’re not talking has restored integrity and trust in For now, low interest rates make about thousands of companies.” U.S. firms. bank debt more desirable than raising Additionally and even more persua- In a 2004 press release on the two- capital through the equity markets, he sive, is an easily overlooked finding in year anniversary of Sarbanes-Oxley, says. So long as S&K’s operations and his study: The negative stock slides of Sen. Sarbanes summed up the case for strategic growth can be funded going-dark firms have been worse the legislation that bears his name: through loans, then there’s no rush since the passage of Sarbanes-Oxley “I believe that we have succeeded in to return to the Nasdaq. That said, than before. To Triantis, that means raising standards,” he said, “with Knowles adds that any reforms by the market is placing a higher value on increasing international support, to the SEC to make Section 404 less bur- disclosure, which by extension ought give investors a new degree of confi- densome for smaller firms would to lift share prices for firms that dence in our capital markets.” Still, change that formula. “There’s no remain SEC-compliant. there are dissenters. Over at S&K question we would reconsider listing Robert Litan, senior fellow in eco- headquarters, CFO Knowles notes if the small-firms issue was nomic studies at the Brookings that Sarbanes is retiring after his addressed,” Knowles says. “I liked the Institution, says that disentangling current term expires in 2006. It’s an idea of being on the Nasdaq. It carried the impact of Sarbanes-Oxley from open question whether S&K stock a lot of clout.” other concurrent developments is can hold up that long in the dark. RF

R EADINGS Benston, George J., Michael Bromwich, Robert E. Litan, and Fuller, Joseph. “So, Why Be Public?” Directors & Boards, Winter Alfred Wagenhofer. Following the Money: The Enron Failure and the 2004, pp. 27-32. State of Corporate Disclosure. Washington, D.C.: AEI-Brookings Leuz, Christian, Alexander Triantis, and Tracy Wang. “Why Do Joint Center for Regulatory Studies, 2003. Firms Go Dark? Causes and Economic Consequences of Carney, William. “The Costs of Being Public after Sarbanes- Voluntary SEC Deregistrations.” Working Paper, Social Science Oxley: The Irony of ‘Going Private.’” Emory University School Research Network, November 2004. of Law, Law and Economics Research Paper no. 05-4, Visit www.richmondfed.org for links to relevant sites and February 2005. supplemental information. Engel, Ellen, Rachel M. Hayes, and Xue Wang. “The Sarbanes- Oxley Act and Firms’ Going-Private Decisions.” Working Paper, Social Science Research Network, May 2004.

18 Region Focus • Summer 2005 TToo bb aa cc cc oo The invisible hand plants first crop BY BETTY JOYCE NASH Buyout ent Hudson has bumped along tobacco road for 35 years, Kjumping at opportunity here and there. “It’s like rolling logs on a river: You got to be steady on your feet and be ready to change directions,” he says. Hudson gave up growing tobacco in 1993 on his farm in the Piedmont near Buffalo Junction, Va., about a mile from the North Carolina line, midway between the mountains and the sea. He’s sold harvesters, planters, and tobacco barns. More recently, he’s been loading up 10- by 30-foot metal tobacco barns and hauling them from the Piedmont into the coastal plains of the Carolinas. That’s because tobacco production is headed east for big, flat plains where efficiency rules. Competition is coming to tobacco fields as growers try the free market. The new law lifts restrictions on Ed Young’s family has raised tobacco in South Carolina The federal tobacco price support and location, size, and amount of tobacco since the 1800s. Young oversees planting of the first crop quota program ended last fall by con- production, leaving the market to grown since the 1930s without price supports. gressional legislation. Hudson’s new decide who grows tobacco best. moving business bears out economists’ raked in some $3 million in 2004 predictions that tobacco farming will Tobacco in the Fifth District tobacco cash, as did West Virginia. But migrate, for efficiency’s sake, to fields Tobacco has been a cash crop since antismoking sentiment and declining where topography enhances instead of 1612, with flue-cured the most com- demand, falling exports, and competi- hinders production. “Those that are mon type produced in the Carolinas tion from imported leaf had led to quitting are selling the barns, and the and Virginia. Flue refers to the curing severe quota cuts over the past few people expanding are buying them,” he process, which uses forced air heat that years. Without price supports, the says. That pretty much sums it up. was once circulated through a flue in market might have sorted itself out Under the legislation, tobacco grow- the barn. years ago. ers and quota owners will receive $9.6 The biggest chunk of the nation’s “Tobacco has been the backbone billion over 10 years, an effort to pay $1.75 billion 2004 tobacco receipts of agriculture in Southside Virginia them for an asset — the right to grow went to North Carolina: $652 million. for many, many years,” says tobacco tobacco — created more than 70 years Kentucky ranked second, Virginia was specialist Stan Duffer of the Virginia ago by the federal tobacco program third with $127 million, and South Department of Agriculture and during the New Deal. (Another $500 Carolina, fourth with almost $110 mil- Consumer Services. “People knew million will go toward disposition of lion. Even Maryland, which bought out how to grow tobacco. Now, we’re in a tobacco held by grower associations.) all but about 150 growers five years ago, different time. Here in Southside PHOTOGRAPHY: BETTY JOYCE NASH BETTY JOYCE PHOTOGRAPHY:

Summer 2005 • Region Focus 19 you’ll see some increase in livestock, culture to mount a public information Tobacco Tradition beef cattle. It’ll go back to supply and campaign to make sure tobacco farm- Heading east on U.S. 176, just off demand, I can assure you.” ers and quota owners know the ins and Interstate 95 in Florence, S.C., there’s Controlling supply was the corner- outs of the deal. The anticipated an elegant white-columned home that stone of the federal tobacco program. buyout money has uncorked a stream dates from 1877. It’s Ed Young’s farm “The idea in economic terms is to of financial planning seminars and and he’s the third generation to work restrict aggregate supply and hope you charitable giving suggestions. that land. He still sleeps in the same raise the price some,” says Blake Brown, That’s because payments, including bedroom where he was born. Young is an economist at North Carolina State those to Fifth District states, will be 84 and aptly named because he climbs University who studies tobacco. The substantial: Growers and quota owners in and out of his big cab pickup truck restrictions on many crops didn’t in North Carolina will receive about easily in spite of a recent hip replace- endure like those on tobacco because of $3.9 billion; South Carolina, $724 mil- ment. On a windy day in late April, international competition. “But with lion; and in Virginia, they will get Young stands in a field of about 32 tobacco, the international competition almost $667 million. Manufacturers acres. A carousel planter, named for its didn’t become intense until the late and importers will foot the bill based rotating part that deposits tobacco 1980s and early 1990s.” And when com- on market share. (The three largest seedlings, crawls along. There are typi- petition intensified, the price support tobacco firms are in the Fifth District cally 6,000 plants to the acre on these program hamstrung tobacco farmers’ and include Philip Morris USA of South Carolina fields of sandy loam. ability to compete. Richmond, Va.; R.J. Reynolds Tobacco Young should know, as his family has In the 1930s, farmers got quotas of Winston-Salem, N.C.; and Lorillard grown tobacco here since the late based on growing history. Tobacco Tobacco Co. of Greensboro, N.C.) 1800s. Young’s uncle met with quota became an asset. To expand, It was essential to compensate Franklin D. Roosevelt before the pres- farmers either bought land with quota, quota owners, Brown notes. “You’ve ident created the tobacco program. rented land with quota attached, or created an asset with value whether This year, Young planted the same bought quota and attached it to land. you intended to or not,” he says, amount of acreage in tobacco under The buyout pays quota owners $7 a adding that the original laws created these new market conditions as he did pound over 10 years based on 2002 the expectation that quota would con- last year under the old quota system, basic quota. Meanwhile, producers who tinue to be valuable. 65 acres compared to the 100 or so he raised tobacco in 2002, 2003, or 2004 The buyout money will allow planted three years ago. He is waiting will be paid $3 per pound over 10 years farmers with inefficient farms or to see what changes the market brings. if they grew tobacco all three years. without successors to retire, Brown “I’m gonna take a chance,” he says. Those who grew tobacco only one or says. (The average age of tobacco farm- “We have a contract with Reynolds.” two of those years will receive propor- ers is about 55.) Others will use the R.J. Reynolds Tobacco Co. is the tionately smaller payments. About money to pay off debt. Some may nation’s second largest tobacco com- 416,000 growers or quota owners are develop businesses or retrain. Whether pany, with about one-third of the out there. The Environmental Working buyout money will stay local and work domestic cigarette market, behind Group, a nonprofit that investigates for these rural communities when Philip Morris USA, with about half farm subsidies, reports the average pay- farmers abandon tobacco, though, is the domestic market. ment will be around $4,396. But about unclear. “What you would hope is that This year, tobacco growers without 462 people, estates, or corporations will quota owners who had been using contracts with manufacturers or leaf average about $1.6 million apiece, quota rent as an income source will merchants aren’t likely to plant. The according to the group’s calculations. invest and if they make wise invest- contract system replaced the outdated Buyout money will be paid in ments, the income will come back into auction warehouses several years ago. 10 equal annual installments — for these local communities to replace The Reynolds contract instructs Young instance, for 500 pounds, a quota quota money,” Brown says. and other growers in his area to ditch owner would get $350 annually — or Out of Kent Hudson’s five nearby the bottom (less valued) eight tobacco farmers may choose other payment neighbors, four quit. One will expand leaves of the tobacco plant’s 19 leaves, options through financial institutions. his road construction business, anoth- which will cut the yield by 20 percent, (This bigger pot of money replaces er bought a dump truck, another will Young says. Some farmers chose not to the rest of the Phase II funds, about add to his cattle herd, and another will plant because they didn’t think they $2.5 billion of the original $6 billion, work for the neighbor who is in the could make money. Dewitt Gooden, scheduled for growers and quota construction business. The loss of the tobacco specialist with Clemson owners under the Master Settlement tobacco crop will have an “effect on University, reckons that this year Agreement of 1998.) the car dealer, the pickup truck dealer, there’ll be about 25 percent less tobac- Wachovia Corp. won a contract the fertilizer people, and the equip- co planted in this region compared to from the U.S. Department of Agri- ment people,” Hudson says. last year.

20 Region Focus • Summer 2005 Maryland Tobacco Settlement Payments in Limbo Young would like to expand, if the ost of Maryland’s tobacco farmers agreed to North Carolina courts jurisdiction in tobacco set- market warrants. His children, grown Ma buyout in 1999, when the state pledged to tlement matters. “[Growers] are losing this and far-flung, are unlikely to carry use money from the Master Settlement stream of revenue they anticipated when they on farming. Raw land near his farm Agreement’s Phase II to compensate them for get- made their decision,” McMillan says. “It’s very sells for $20,000 an acre, and substan- ting out of tobacco. But those payments ended unfair to them.” tial subdivisions are plopped down when the tobacco buyout legislation was passed Farmers participating in the Maryland pro- adjacent to fields. “It’s hard to farm last fall, leaving Maryland farmers in the lurch. gram are paid $1 per pound annually over land worth $20,000 an acre,” he says. Maryland farmers opted out of the federal 10 years, based on the average amount of tobac- Tobacco contract prices, says Blake price support system in the 1960s; none will co produced between 1996 and 1998. In Brown of N.C. State, have fallen by receive money from the current federal buyout exchange, farmers agreed to quit growing tobac- the amount of the quota rent — about program. Pennsylvania tobacco farmers are co and use the land to grow other crops for at 40 cents to 50 cents a pound. The in the same boat, since they also did not least 10 years. By 2005, 86 percent of producers farmers with the most competitive participate in the federal tobacco program. were taking the buyout. yields will make money; others will “We had roughly 1,000 individuals receiving Maryland tobacco farmers have always been not. Field size, fixed costs, equipment payments from the trust whose payments a different breed: They grew the unique Type 32, costs, labor costs, and good manage- are now in jeopardy,” says Patrick McMillan, known for slow and even burning. ment will determine profitability, like an assistant secretary of the Maryland The tobacco was sought after in the European any other business, says Brown. But Department of Agriculture. Maryland farmers had market and prices over the years were strong. the single biggest factor to success is seven payments remaining, worth a total And domestic firms bought the grades the the productivity of the land itself. of about $12 million. Europeans didn’t want. That’s probably one of the Oversupply from last year’s crop Farmers covered by the Master Settlement biggest reasons why Maryland farmers decided kept contract amounts low this year, Agreement have not received money for 2004 to get out of the federal program, says David says Jim Starkey, senior vice president because tobacco companies say they’re not Conrad, regional tobacco specialist with the of Universal Corp., based in obliged to make that payment now that University of Maryland’s cooperative extension Richmond, one of the biggest leaf mer- the buyout has replaced the Phase II schedule. service. “When you put those prices [domestic chants in the world. Without The matter is now with the North Carolina and European] together, there was no need for production limits, the better farmers Supreme Court. Original trust papers gave the price supports,” he says. —BETTY JOYCE NASH will grow more under contract, Starkey says. Taking the quota price out of the equation removes a nonproductive try growing burley tobacco now that Most mountain burley growers will cost from the system, he notes. there are no restrictions on where cer- quit tobacco because the steep terrain “What a grower actually receives tain tobaccos can be grown. Burley was and small plots curtail efficiency. will depend on what he actually pro- traditionally raised on the fringes of the Without the guaranteed tobacco price, duces in a given year,” Starkey says. “If Appalachians. Burley is labor-intensive they won’t make money. Some growers he has a good year and produces a and grown in a slightly cooler climate in the Piedmont are planting burley, higher quality tobacco, his income will than flue-cured. The entire stalk is cut, but, of course, it’s untried and risky. go up.” hung, and air-cured. Starkey says Ed Young watched his father turn Even though production of flue- humidity prevents burley production in to dairy after the boll weevil wiped cured tobacco will increase in the the tropics, the source of most interna- out cotton. He’s lived to see cotton coastal plains, there will be some tobac- tional tobacco competition. revive and dairy production move on co grown in the Piedmont, Brown says. “In the case of burley, I think the to greener pastures. He plans to invest That’s because buyers like to spread core will still be in Kentucky and in equipment and perhaps in another risks and avoid weather extremes or Tennessee, but since so many growers farm. Other farmers in his neighbor- other possible production problems. will be getting out of the burley pro- hood are putting land in timber or Jim Starkey says Universal has contracts duction area, I think we’ll start to see trying new agricultural enterprises. in all five flue-cured producing states. that production move to new areas and As for the rest, the money greases the Some flue-cured tobacco farmers will the Piedmont is one,” Starkey says. way out. RF

R EADINGS Brown, A. Blake. “U.S. Flue-Cured Tobacco Outlook and Johnson, Paul R. The Economics of the Tobacco Industry. New York: Situation.” Department of Agricultural and Resource Economics, Praeger Publishers, 1984. North Carolina State University, Dec. 8, 2004. Visit www.richmondfed.org for links to relevant sites and Brown, A. Blake, and Laura L. Martin. “Price versus Quota supplemental information. Reductions: U.S. Flue-Cured Tobacco Policy.” Journal of Agricultural and Applied Economics, December 1996, vol. 28, no. 2, pp. 445-452.

Summer 2005 • Region Focus 21 REDEVELOPMENT BOOT CAMP

To survive the latest round of base realignments and closures, military-centric communities will have to find ways to turn barracks and bombing ranges into

something marketable BY CHARLES GERENA

talkative group fills the restau- uniform. Actually, there is something by the Virginia Army National Guard, rant booth near the front door else different. The long, flat building which manages it pretty much as the Aof Ida’s Kitchen. They chew looks like it belongs on an Army base. U.S. Army did for more than 50 years. the fat about the latest movies and In fact, Ida’s operates in what used to “The military presence continues, exchange neighborhood gossip while a be a mess hall that fed soldiers stationed and thank goodness for that,” says Joe gray-haired lady listens quietly from a at Fort Pickett. Outside, C-17s prac- Borgerding, a bank manager in Black- chair pulled up beside the booth. She tice sorties at a nearby airfield four stone who recently served on the board is the owner of the establishment, times a week. Sometimes, they fly so of the local chamber of commerce. And which provides catering services low that a passing motorist can almost a small section of Fort Pickett made throughout rural Southside Virginia as make out the pilot’s face. available for private development has well as a hot platter of Southern cook- Fort Pickett covers 42,000 acres, supported some economic activity, ing for walk-ins. making it larger than Washington, D.C. mostly small businesses like Ida’s Right away, two things stand out. The vast facility’s economic influence Kitchen. Only one man is seated at the booth, spreads even farther, encompassing the Other localities in the Fifth District and he is dressed in the camouflage small town of Blackstone and sur- lost military installations during the four colors of an Army National Guard rounding Nottoway County. Both fared previous BRAC rounds between 1988 OK after Fort Pickett landed on the and 1995, but they were spared the Most of Fort Pickett, which covers more ground than Base Realignment and Closure (BRAC) major closures that shook up commu- the nation’s capital, was retained by the military list in 1995. The facility was taken over nities in states like California. (The big rather than redeveloped. exception was the shutdown of the Charleston Naval Complex, which cost the South Carolina city thousands of jobs.) In fact, a few places like Naval Air Station Patuxent River in southern Maryland and Marine Corps Air Station Cherry Point in eastern North Carolina enlarged when they received personnel from closed facilities. The Fifth District may dodge the bullet again. Fort Monroe in Hampton, Va., was the only major installation tar- geted for closure when Defense Secretary Donald Rumsfeld announced the preliminary 2005 BRAC list in May. And Naval Station Norfolk in Virginia, Fort Bragg in North Carolina, and other PHOTOGRAPHY: COURTESYPHOTOGRAPHY: OF FORT PICKETT

22 Region Focus • Summer 2005 Long Recovery Only two of the five major base redevelopments in facilities could end up with a net gain One of the researchers who reached the Fifth District have managed to produce enough in employment once the dust settles. this conclusion is Ted Bradshaw, a com- jobs from private-sector investment to replace the But a nine-member commission can munity development expert at the civilian jobs lost post-BRAC. modify Rumsfeld’s list before they University of California-Davis. “If you Loss Gain present it to President Bush for his con- are losing a base [that] has thousands of Charleston Naval Complex, SC 6,272 2,797 sideration in September. Until then, people, you cannot assume that your (BRAC 1993) every community with a major military economy is going to go down the Fort Pickett, VA 245 272 presence faces an uncertain future. tubes,” he says. “You don’t have that (BRAC 1995) It’s hard to generalize about how well local customer base [anymore], but the Fort Ritchie, MD 1,373 42 they will fare judging from Fort Pickett’s net effect over a number of years is (BRAC 1995) experience alone, especially since the going to be possibly neutral or positive.” Myrtle Beach Air Force Base, SC 784 1,571 installation was “realigned” instead of For individual communities recover- (BRAC 1991) closed. But the effects of previous ing from a closure, though, the short run Vint Hill Farms Station, VA 1,472 901 BRAC rounds on communities like can be painful. “The recovery process (BRAC 1993) Blackstone and efforts to mine the eco- has not necessarily been easy, with the nomic potential of military installations strength of the national, regional, and SOURCE: Office of Economic Adjustment, like Pickett offer some important local economies having a significant U.S. Department of Defense lessons. Most importantly, the odds of bearing on the recovery of any particu- success increase when redevelopment lar community facing a BRAC closure,” city of Concord, Calif., lobbied for the complements what the local community noted the 2005 GAO report. closure of a naval weapons station in the already does well. The shutdown of a military installa- next BRAC round so that land would “Rome wasn’t built in a day, and you tion tends to hurt rural communities be available to meet the soaring demand aren’t going to redevelop bases in a day more than urban locales. Bradshaw and for residential development in the hot either,” advises William Harvey, former others say that’s because such facilities Bay Area housing market. (They got chief of the Army’s BRAC office and account for a relatively large share of their wish.) president of an Alexandria, Va., con- employment and spending in an In some cases, the traits that made sulting firm that helps redevelop economy with a relative lack of business former bases attractive to the military federal property. “The time [required] diversity. The impact of a closure also are also conducive for civilian applica- is based on the area’s absorption capa- depends on the type of installation, tions. For instance, naval facilities could bility and the demand for that type which determines how much of its be well suited for port operations, while of property.” payroll and procurement dollars are other installations with aviation infra- spent locally. (See the cover story, structure could support commercial Being “Brac”-ed “Dollars and Defense,” in the Summer air traffic or house a plane maintenance Before the release of the initial 2005 2003 issue of Region Focus.) facility. BRAC list, news stories appeared with The Army built Fort Pickett during However, there are costs involved in ominous headlines like “Base Closings World War II to prepare Army soldiers realizing the potential value of a mili- Will Hit Like Tsunamis.” Past experience and reservists for battle. Tens of thou- tary installation, some of which are doesn’t justify this level of pessimism. sands of these warriors spent money borne by the Defense Department and A recent analysis by the U.S. Gov- locally during their stay, while the facil- some of which fall on other people’s ernment Accountability Office found ity employed hundreds of civilians to shoulders. Depending on the desirabil- that about 85 percent of local civilian maintain the grounds and purchased ity of the site, these expenses may make jobs lost during previous base closures some supplies locally. Fort Pickett it difficult for developers to get a good have been replaced through the devel- revved up again during the early 1950s return on investment. “Where there is opment of the properties. “Two key to prepare soldiers for combat in North the will, there is a way … and where the economic indicators — the unemploy- Korea, then evolved into a transient economics support it,” notes consult- ment rate and the average annual real facility for training armed forces. ant Bill Harvey. per-capita income growth rate — show President Bush recently proposed that BRAC communities are generally Fire Sale converting bases into oil refineries. The doing well when compared with With the potential negative effects of permitting process for such conversions average U.S. rates,” the report states. a base closure on a local community might be easier compared to building a Other research has found that, in the come the potential benefits of freeing refinery on a virgin site. But energy ana- aggregate, the economic effects of a up military real estate for civilian use. lysts note that many bases aren’t near base closure don’t spread far beyond the For installations where urban develop- existing pipelines or large bodies of immediate vicinity over the long run. ment encroaches upon its borders and water that are accessible to oil tankers, Even then, the ripples rarely become land is at a premium, their property plus they may be too contaminated for the tsunamis that people predicted. could prove very valuable. In fact, the refiners to deal with cost effectively.

Summer 2005 • Region Focus 23 Indeed, many military installations some repair work on water and sewer Although the 1995 BRAC report have problems similar to brownfields. lines before the land transfer. Three noted that Fort Pickett was “low in mil- “They have major toxic conditions buildings transferred for redevelopment itary value compared to other major [in soil and groundwater] that have were demolished, but others were in training area installations,” the Pentagon to be remediated,” notes Debbie Kern, good shape and the Army repaired reportedly decided that the Virginia a San Francisco-based real estate a few beforehand. Consequently, many Army National Guard could run it at a consultant who specializes in base structures are being reused as is, from a lower cost than the regular Army could conversions. Additionally, installations bowling alley to a chapel run by a former and still train troops throughout the usually have at least some buildings Pickett commander. Mid-Atlantic. and infrastructure in need of upgrading In addition to the remediation and Today, about 900 military personnel, or replacement. On top of these brown- infrastructure work that may be civilians, and contract employees work field issues, installations may have required before a military installation in the 42,000 acres that the Guard unexploded bombs and other munitions is ready for transfer, there is the trans- manages as a Maneuver Training Center. that defunct industrial sites don’t have. fer process itself. First, the Pentagon It includes several specialized firing All told, dealing with these issues sees if it can use any of the property. ranges and a 16-building mock city used takes a lot of time and resources. Unless Whatever it considers to be excess is to practice urban warfare. The Defense it does an early transfer, the Pentagon then up for grabs by other federal agen- Department retains ownership of the usually doesn’t turn over an installation cies. Any land remaining is declared center, as well as 90 acres used by the until it is suitable for civilian use. That surplus and signed over to new owners, U.S. Army Reserve. can take decades, according to Kern, either through a direct sale or a variety Whether a facility’s economic depending on the amount of remedia- of conveyance mechanisms. impact changes after realignment tion and infrastructure work required. In Fort Pickett’s case, Nottoway depends on the facility. Soldiers from Nottoway County was fortunate County received its chunk of the various branches of the armed forces, because much of the infrastructure in the facility for free under an economic along with law-enforcement profes- 1,654 acres of Fort Pickett transferred development conveyance, which Kern sionals and foreign troops, still come to its Local Redevelopment Authority says is a somewhat expedited process. to Fort Pickett to sharpen their skills. was in good shape. The utilities had been Still, it took five years for the transfer But while more people cycle in and out operated by outside entities before to be completed. of Pickett, they stay for shorter train- Pickett’s realignment, and the Army did ing periods due to long-term changes Private vs. Public in how the military operates and short- Land Grab Given the pecking order of base reuse, term adjustments in response to the war how much land ends up in private on terrorism. This translates into less Uncle Sam has snatched up more than half of the hands and how much of it gets gobbled spending off base. 854,000 acres of military installations declared up by Uncle Sam first? More than half Fort Pickett itself still spends money unneeded after four rounds of base closures and of the property declared unneeded in locally, from rock used to cover 210 miles realignments. The Department of Defense expects four previous BRAC rounds — of trails to contractors who maintain the untransferred property will eventually go to 450,000 acres, to be exact — has been and build new training areas. Officials nonfederal users, including local redevelopment retained by the Defense Department estimate that the base spent between authorities and private developers. for reserve and National Guard units, $1.5 million and $2.5 million in 2004. Untransferred or transferred to another federal agency In the Fifth District, there are other Retained by DOD for 49,000 thus far. Only 31 percent, or 264,000 examples of base realignments. A naval Untransferred, reserve component use acres, has gone to new owners outside technical center in St. Inigoes, Md., now but leased 350,000 of the U.S. government, including local operates as an annex to NAS Patuxent 91,000 6% redevelopment authorities and private River located 13 miles away. There also 10% developers. (See chart.) are examples of federal reuse of military 41% Fort Pickett was supposed to be installations. A massive campus for the mothballed. That didn’t happen due Food and Drug Administration is being 31% to lobbying by officials like the late developed in Silver Spring, Md., at a U.S. Rep. Norman Sisisky to have the former naval warfare center. The Federal 12% Virginia Army National Guard take Aviation Administration operates a over management of most of the facil- regional air traffic control center in part Transferred to ity. Also, then-Gov. George Allen of Vint Hill Farms, a former communi- nonfederal entities Transferred to lobbied for state officials to move the cation station in Fauquier County, Va. 264,000 federal entities 100,000 Department of Military Affairs, which At Fort Pickett, Virginia Tech received oversees the state’s National Guard 1,184 acres that had been transferred SOURCE: U.S. Government Accountability Office operations, to Pickett. from the military to the U.S. Department

24 Region Focus • Summer 2005 of Education. The university used the firms in the county-controlled industrial property to create a centralized campus park. If the Virginia Army National for its Southern Piedmont Agricultural Guard didn’t take over most of Pickett, Research and Extension Center. Other a move that boosted the facility’s public facilities at Pickett include a satel- military and civilian employment from lite campus for Southside Virginia around 750 in August 1995 to well over Community College and a driver train- 900 today, there likely would have been ing facility for state police. a net employment loss after BRAC. While there has been extensive public Given the availability of industrial space reuse of bases, private uses are equally in Southside Virginia, including a site As many as 88,000 troops train at Fort Pickett important. “It is with the value created in Nottoway County just a few miles annually, though they stay for shorter periods by private development, along with from Fort Pickett, it probably wouldn’t than before the 1995 BRAC changes. subsidy sources, that you are able to add have been worthwhile for a developer to the public benefits,” says consultant to clean up the active part of the instal- One unique asset Pickett Park has Debbie Kern. “You have a new tax base.” lation. About 15,000 acres is an impact is trees — average annual sales of timber zone heavily contaminated with shells in Nottoway County were $7.2 million When Uncle Sam and other debris from weapons fire. from 1986 to 2001, ranking the county Doesn’t Want You “Why would a developer want to pay fourth in the state. It is this ample Yet the hardest part of the redevelop- for a military base that comes encum- supply of timber that probably attracted ment process can be attracting private bered with ancient utilities and facilities ArborTech and Trout River Lumber, investment in a former military instal- and its own environmental problems which occupied a hangar at Pickett Park lation. Depending on whether the such as lead-based paint and asbestos until it built a new facility in Crewe. facility has something that the market … when right next door might be a clean Also, a World War II-era officers club wants, it can take awhile to replace lost piece of property … that they can get has been beautifully restored into an military and civilian jobs. at the same price, or maybe cheaper?” event and meeting space. The club has Since 2000, Nottoway County has asks Ken Matwiczak, a public affairs pro- attracted a lot of business because it is been turning its acreage at Pickett into fessor at the University of Texas at one of the few facilities of its kind avail- an industrial complex called Pickett Park, Austin. He is currently working on a able in Nottoway. but progress has been slow. Currently, report for the Congressional Research It is much harder for a redeveloped the park’s largest tenant is a lumber pro- Service on the economic aftermath of military installation to support new ducer named ArborTech Forest Products. BRAC rounds in rural communities. industry, especially in remote rural areas The company’s $26 million, high-tech saw Fort Pickett is one of 16 installations with limited economic activity to lever- mill employs 65 people, 15 more than orig- his graduate students visited. age. “[Large corporations] don’t have a inally projected in 2000. Another The key to a successful redevelop- reason to come to rural areas,” says company was supposed to invest $13 ment is finding something about a base Matwiczak. “… There isn’t transport- million and hire 100 people, but its prin- that uniquely addresses an existing need ation infrastructure [or] opportunities cipals couldn’t obtain the financing they in the marketplace. Vint Hill Farms and to interact with other industries.” needed to get rolling. Several smaller firms Cameron Station were turned into Military base closures hurt. Whether have moved into buildings that the mil- mixed-use developments to take advan- communities can recover from the loss itary had used, while the county operates tage of the demand for housing in ultimately depends on how they utilize a business incubator and rents out former Northern Virginia, while part of Myrtle market forces. “You have some tools barracks as single-occupancy housing. Beach Air Force Base became an airport that can somewhat offset it,” notes Overall, only 155 of the 1,131 people that supports coastal South Carolina’s Kern, “but base development has to be working at Fort Pickett are at private burgeoning tourism trade. primarily market-driven.” RF

R EADINGS Bradshaw, Ted K. “Communities Not Fazed: Why Military Base “Military Base Closures: Observations on Prior and Current Closures May Not Be Catastrophic.” Journal of the American BRAC Rounds.” Washington, D.C.: U.S. Government Planning Association, Spring 1999, vol. 65, no. 2, pp. 193-206. Accountability Office, May 2005. Frieden, Bernard J., and Christie I. Baxter. “From Barracks Warf, Barney. “The Geopolitics/Geoeconomics of Military Base to Business: The M.I.T. Report on Base Redevelopment.” Closures in the USA.” Political Geography, September 1997, Washington, D.C.: Economic Development Administration, vol. 16, no. 7, pp. 541-563. U.S. Department of Commerce, March 2000. Visit www.richmondfed.org for links to relevant sites and supplemental information.

Summer 2005 • Region Focus 25 A MENU OF OPTIONS

A Richmond Fed economist says that giving financial institutions limited choice about how they are regulated may produce a more stable and efficient

banking system BY ANDREW FOERSTER

et’s say a stranger One of the roles of the comes to you and Federal Reserve System is to Lwants to borrow a sig- regulate banks and ensure nificant amount of money. If they are behaving in a manner you’re reasonable, you’ll sit that is not too risky. The Fed back and assess the interest shares this duty with several rate that you may charge, the other institutions at both time you’ll let the loan go the federal and state level. before repayment, and then These regulators have a you’ll think about the chance responsibility to the public that the stranger won’t repay of preventing banks from the loan. You may be making overly risky loans extremely careful in deter- because of moral hazard, mining whether the risk of protecting the money of not being repaid is worth the depositors, and encouraging benefit of some additional banks to only make loans for interest in the future. Now projects that have a high imagine that the money you probability of success. are considering lending is The cost to society of hav- money that you yourself have ing risky banks fail because borrowed from a second of bad loans is potentially stranger. How will your deci- very high. During the 1980s, sion be affected? for example, savings and You may be a little less loan banks, burdened with concerned if you are loaning loan portfolios ruined by out someone else’s money. If high inflation, turned to your loan is repaid, then you making excessively risky keep the interest and pay loans, attempting to recover. back your own creditor. If the Many of these risky loans loan fails, you go tell your creditor you’ve lost the money. You backfired, and the result was a massive number of failures keep the money if you win, and leave someone else with the and large government bailouts. bill if you lose. This situation is an example of what econo- In a perfect world, regulators would be able to easily mists call moral hazard: You have incentives to take risks monitor banks’ loan portfolios, somehow understanding because you can pass the bill if things don’t go your way. the risk of each and every loan and therefore the risk of the Borrowing from and lending to strangers is what banks entire portfolio. Reality, however, is more complicated. do every day. Depositors lend banks their money by placing Occasionally, a bank may have some unexpected shock to it in savings and checking accounts, and banks put all of its portfolio — such as a sudden change in the risk of a loan their deposits together and then make loans to individuals or — and the bank knows about the shock but the regulator businesses that are looking for extra cash. And since bank does not. This discrepancy in information between regula- deposits are generally guaranteed up to $100,000 by the tors and banks is an example of what economists call Federal Deposit Insurance Corporation (FDIC) — meaning hidden information. that depositors don’t think about bank risk because they’ll For an external inspector like the Fed, monitoring get their money back — banks can have an incentive to favor hidden information and managing moral hazard is of high-risk, high-reward loans. central importance. Research by economists at Federal PHOTOGRAPHY: GETTY IMAGES PHOTOGRAPHY:

26 Region Focus • Summer 2005 Reserve banks and universities looking Jensen and William Meckling, who use Basel II is designed to change capital at various ways regulators can handle contract theory to discuss firm behav- regulation mainly for large, interna- hidden information and try to control ior. In their 1976 paper “Theory of the tionally active banks. The new moral hazard has led to consensus on Firm: Managerial Behavior, Agency standards focus on three broad pillars: broad issues, but occasional disagree- Costs, and Ownership Structure,” they identifying and controlling risk, ment over details. Ned Prescott, an identified the equity owners as the supervisory review, and market super- economist at the Richmond Fed, has decisionmakers of firms. The managers vision. More sophisticated than that two proposals to manage these two of banks would, they concluded, act in of Basel I, the capital regulation of problems. First, he advocates giving the best interests of the equity owners Basel II relies heavily on a bank’s self- banks limited choices as to how they of the firm and not necessarily the debt assessment. Using their internal are regulated, with the idea they will holders. Specifically, the equity holders models of risk, each bank will report self-select options that help regulators only care about the positive side of the to the regulator their estimates of sev- monitor hidden information. Second, risk — they hope to make a profit on eral figures, including risk and losses he argues for close examination of their investment and do not care if the given default, for each loan. This high returns as a way of managing bank loses the debt holders’ money. assessment then determines the capi- moral hazard. Equity holders, though, do care tal requirements that the bank has to about losing their own money, so the meet given its overall risk. A Wide Degree of Uncertainty way to control risk-taking incentives The issue of regulation therefore The economics literature differs is to keep debt financing down. This returns to one of hidden information in the details regarding prescriptions is the logic behind capital require- between the regulator and the bank. for regulating banks. In practice, ments. Banks are highly leveraged Even if the regulator has some infor- regulation relies heavily on capital firms — a large part of their funding mation, the bank will always have requirements, which limit the amount comes from deposits, which are essen- more. What then has Basel II solved? of leverage, or deposit financing, a tially a form of debt financing. The In order for the system to work as bank can engage in. greater a bank’s capital — its equity as a planned, incentives must be provided So what is the optimal capital struc- fraction of assets — the more equity to make banks report risk accurately. ture for banks? Economists do not holders have to lose. Clearly, nobody understands a bank’s agree on any one theory of capital In recent decades, globalization has risk better than the bank, so self- structure for general firms. When con- put banks from different countries in assessment will be better than sidering a specific industry such as competition with one another, so the anything an outsider could produce. banking, the disagreement grows. financial community must strive for With regard to general firms, a cele- not only ideal capital regulation in the New Proposals from a brated paper by Nobel Laureates United States, but also ideal capital Fed Economist Franco Modigliani and Merton Miller regulation in the entire world. Ned Prescott, an economist in the from the 1950s, “The Cost of Capital, With this push toward global bank- field of banking regulation theory at Corporation Finance, and the Theory ing competition in mind, the United the Richmond Fed, advocates several of Investment,” argued that in a perfect States entered into the international novel approaches to regulating banks economy, a firm’s capital structure did Basel Accord in 1988, which set gener- under Basel II. After doing his disser- not matter. They found that invest- al standards for capital regulation of tation at the University of Chicago on ments funded by borrowing or equity banks in all agreeing countries. The contract theory and sharecroppers in were equivalent because firm value standards set by Basel I, however, were less developed countries, Prescott depended only on the future stream of fairly primitive, as capital require- looked for other ways to use the wide- income from the investment, not on ments only depended on the types of ly applicable tools of contract theory. how the firm financed the investment. assets a bank held. Each bank, with lit- He turned to researching bank In showing what did not matter, tle regard to its loan portfolio’s risk, regulation, a change that came natural- Modigliani and Miller helped point had a set percentage of its assets that it ly, he notes, because “contract theory financial economists toward what had to hold as equity. The assessed risk models were well designed to address did matter — departures from the on each loan in a bank’s portfolio bank regulation issues.” Specifically, model’s perfect economy. A variety of depended on broadly based categories contract theory, originally developed departures such as taxes, bankruptcy — such as commercial versus govern- to handle insurance problems created costs, and agency costs have been ment loans — that generally told little by moral hazard and hidden inform- developed. about the risk of each loan. ation, could look at deposit insurance in One specific departure from The deficiencies of the Basel the banking industry. “A lot of bank Modigliani and Miller, and one Accord led to a follow-up agreement, regulation deals with perverse incen- considered highly relevant for bank Basel II, which is currently under tives caused by deposit insurance, so regulation, is the work of Michael consideration in the United States. contract theory is a natural fit for study-

Summer 2005 • Region Focus 27 ing bank regulation,” Prescott says. Free to Choose Prescott’s research agenda fits The striking result is that This idea of using a menu of con- nicely with critical elements of Basel tracts is not relevant only to II. He sees the new accord as a regulators will inspect the banking regulation — insurance step forward in bank regulation, but companies use it all the time. For only if implemented properly. To relatively safe banks with example, most auto insurers let you be successful, it must address banks’ choose your coverage from several incentives to conceal private infor- lower capital requirements. packages. You assess your risk, and mation about risk. “What incentive choose a package with deductibles, does a bank have to report the true coverage, and payments that fit risks of its assets?” he asks. “Without from declaring that they are safe your risk most appropriately. Since the adequate supervision and appropriate banks.” Banks wish to avoid penalties, situation is similar in banking, it makes penalties, the answer is, ‘Not much.’” which they incur if inspections find sense for the regulators of banks to give With this need for supervision in that they did not hold enough capital similar options to the banks under mind, Prescott focuses his research on for their risks. Banks that do not want their supervision. ways bank regulators can manage the to be penalized during inspections Prescott’s personal experience con- problems of moral hazard and hidden will accept tougher capital regula- tains another example of a menu of information. Traditionally, regulators tions; banks that wish to have eased contracts in regulatory environments. use inspections and sanctions to capital restriction accept the possibil- He recalls a trip to Mexico, where each ensure that banks meet capital ity of getting an inspection. individual going through customs had requirements. Using these traditional The reason the regulator doesn’t to choose a line: green or red. People tools in flexible ways, Prescott finds, inspect risky banks is that those in the green line had a low probability can lead to a more efficient bank regu- banks have admitted to being risky by of being searched, but violations car- lation structure and better results accepting higher capital require- ried hefty fines. Those in the red line from the banking sector. ments. “[With proper penalties] no were automatically searched, but But how does the regulator achieve one wants to claim to be riskier than lower fines accompanied violations. this efficient structure and ensure that they actually are, [so] inspecting a Since officials clearly stated the nature banks follow the rules when it cannot bank that claims it is the highest risk of each line, travelers could choose the perfectly monitor banks? In other is unnecessary,” Prescott asserts. option that fit them best. In a similar words, since regulators have limited “This bank has agreed to hold more manner, Prescott believes, banks resources, what is the best way to allo- capital, and that is all the regulators should be able to choose from a menu cate those resources in regulating desire.” In the end, banks are not the option that fits best. banks? Prescott’s theories challenge hiding any information, as they self- Despite the political or legal barri- the traditional way that banking regu- report the right amount of capital ers, Prescott points to practices that lation is performed. He feels that his they should hold. mimic the menu of contracts approach. proposals to discourage banks’ risk- The advantage of this capital “Some practices use menus of contracts taking are cost efficient and will not requirement and inspecting struc- implicitly,” he says. For example, the inhibit the actions of safe banks. ture is that banks choose their own internal models approach to banking Prescott thinks one way to regulate capital level from several options in a regulation — presently used for a por- banks easily is by giving banks choices way that reveals their true risk level. tion of a bank’s portfolio — requires from a menu of capital requirements Prescott’s ideas for a menu of con- banks to estimate their own value-at- and inspection intensity. Banks that tracts extend from the original risk, which is a statistic estimating look similar from the outside might “precommitment approach,” advo- potential losses. Based upon this statis- face a trade-off along the following cated by Paul Kupiec and James tic, banks must set a certain level of lines: the higher the capital require- O’Brien of the Fed’s Board of capital. Since their internal models ment, the less intense the inspection. Governors. Under the precommit- determine their capital requirement, The striking result, Prescott says, is ment approach, banks would set banks can alter those internal models to that regulators will end up inspecting their own capital requirements, yield preferred results. Specifically, a the relatively safe banks that have much like under Basel II, and then bank can make its estimates risky or lower capital requirements. incur fines if they ended up not hold- safe in order to influence the exact Isn’t this counterintuitive? ing enough to cover any losses they amount of its capital requirement. But Shouldn’t regulators inspect risky received. This basic self-selection the bank is penalized if losses on the banks, not safe ones? Not exactly, says extends to a menu of contracts by portfolio exceed the capital they hold. Prescott, noting, “The reason for this offering specific options rather than Prescott also studies the presence of seemingly counterintuitive result is letting banks set arbitrary capital moral hazard, which encourages banks that inspections prevent risky banks levels. to make risky loans, particularly when

28 Region Focus • Summer 2005 they are poorly capitalized or in bad produce high returns, but sends a clear Responding to the criticisms that economic condition. Over time, banks signal that a bank is excessively risky. their proposed fine system would face that submit to this temptation will typ- One way to discourage this risk, implementation barriers and stymie ically have more variation in their Prescott argues, is to use regulatory con- innovation, Prescott and Marshall returns than those banks that have rela- tracts that include fines when banks suggest using inspections rather than tively safe and steady loan portfolios. generate extremely high returns, fines. That is, instead of fining banks Risky banks understand that some of because it discourages high risk-taking that produce extra-high returns, their loans have a significant chance of strategies. regulators could trigger inspections failing, but hope to reap significant In “Bank Capital Regulation with to determine if the returns resulted gains from those which are repaid. and without State-Contingent from financial innovation or inappro- The savings and loan banks of the Penalties,” with co-author David priate risk. In this way, the high 1980s provide a good example as to Marshall of the Chicago Fed, Prescott returns act as a sort of “red flag” signal what happens when banks gamble. The admits, “the particular form taken by to regulators. inflation of the early 1980s significantly the optimal fine schedule is somewhat These banking regulation propos- decreased the values of loan portfolios unusual.” In a subsequent paper “State- als would help reduce the risk that of many of these savings and loan Contingent Bank Regulation with banks take, a good result for society. banks, putting them on the path to Unobserved Actions and Unobserved Risky banks that fail can lead to large financial ruin. In an attempt to break Characteristics,” the same authors payments from the FDIC to deposi- even, these banks made more and more admit that the contracts that they advo- tors, which costs the government risky loans, hoping that having a few cate “often require fines on high returns, money. In addition, risky banks make succeed would bring in enough profit to an approach that could encounter polit- loans to businesses or individuals that keep the bank alive. If these risky loans ical and even legal obstacles.” are not deserving of the loan because did not pay off, the bank would still be Others have raised concerns as of low probability of repayment. In insolvent, or no worse off than before well. John Boyd of the University of other words, risky banks help fund making the loans. Minnesota, in published comments on inefficient projects. The loans made This strategy of “gambling for res- Prescott and Marshall’s work, worries to the undeserving groups could be urrection” stands in contrast to sound about the proposed fines’ effects on made to companies or people with banks, which did not need to make the innovation. He notes, “It would be better plans for using the funds. extremely risky loans to stay afloat. extremely difficult for regulators to Prescott hopes to expand his These safer banks could continue distinguish between large profits due research in the future to consider the making lower-risk, “safe and prudent” to risk-seeking and those due to finan- third pillar of Basel II, which focuses loans because they did not face a finan- cial innovation.” Pointing to several on market supervision. He is looking cial crisis. risky innovations in the 1990s that into how regulators can use market Banks that make unusually high turned out to be successful, he worries, data to help create better regulatory returns, therefore, may be in financial “there would be social costs to any tax environments, allowing banks to trouble and gambling for resurrection. scheme which penalized such mar- do business while encouraging safe The risky gambling may pay off and velous innovations.” practices. RF

R EADINGS Boyd, John. “Bank Capital Regulation with and without State- of Richmond Working Paper no. 04-02, February 2004. Contingent Penalties: A Comment.” Carnegie-Rochester Conference __. “Bank Capital Regulation with and without State-Contingent Series on Public Policy, June 2001, vol. 54, no. 1, pp. 185-189. Penalties.” Carnegie-Rochester Conference Series on Public Policy, Jensen, Michael C., and William H. Meckling. “Theory of the June 2001, vol. 54, no. 1, pp. 139-184. Firm: Managerial Behavior, Agency Costs, and Ownership Modigliani, Franco, and Merton H. Miller. “The Cost of Capital, Structure.” Journal of Financial Economics, October 1976, vol. 3, Corporation Finance, and the Theory of Investment.” American no. 4, pp. 305-360. Economic Review, June 1958, vol. 48, no. 3, pp. 261-297. Kupiec, Paul H., and James M. O’Brien. “The Pre-Commitment Prescott, Edward Simpson. “Auditing and Bank Capital Approach: Using Incentives to Set Market Risk Capital Regulation.” Federal Reserve Bank of Richmond Economic Requirements.” Board of Governors of the Federal Reserve Quarterly, Fall 2004, vol. 90, no. 4, pp. 47-63. System, Finance and Economics Discussion Series Paper no. 1997-14, March 1997. __. “The Pre-Commitment Approach in a Model of Regulatory Banking Capital.” Federal Reserve Bank of Richmond Economic Marshall, David A., and Edward Simpson Prescott. “State- Quarterly, Winter 1997, vol. 83, no. 1, pp. 23-50. Contingent Bank Regulation with Unobserved Actions and Unobserved Characteristics.” Federal Reserve Bank Visit www.richmondfed.org for links to relevant sites.

Summer 2005 • Region Focus 29 YOUTH MOVEMENT Blacksburg, Va., and Morgantown, W.Va., are counting on their local universities to create good-paying jobs that will keep kids from leaving town after graduation.

But is that realistic? BY DOUG CAMPBELL

ou could do worse, much worse, than Blacksburg in What a great place to live. If only there were more the spring. This time of year the rolling landscape good jobs. Y in southwest Virginia is popping with purple and That’s where Joe Meredith comes in. He is president of green, the mountain air crisp. The campus of Virginia the Virginia Tech Corporate Research Center, which 10 Polytechnic Institute and State University, more famously years ago was hardly worth mentioning but today is home known as Virginia Tech, bustles with backpack-bearing to 1,830 high-tech, mostly private-sector workers. The CRC students and brisk-walking faculty. Throughout town the was established in 1985 as a for-profit subsidiary of the streets appear to be recently paved and they are clean. Virginia Tech Foundation; its mission is to at once advance technology-transfer operations at Virginia Tech as well as to spur the economy of southwest Virginia. Today it makes its own money and does not draw on university funds. On a recent afternoon, Meredith was chatting with a visitor over grilled chicken sandwiches at the research cen- ter’s on-site café when a park tenant wanders over. Meredith looks up and says, “I got a resume this morning from a guy whose wife has been accepted to the vet school. He’s a marketing guy.” The tenant is chemistry professor and entrepreneur Ketan Trivedi. His face brightens with this news: “We need him,” Trivedi says emphatically. “Send him to us please. Right away.” Meredith nods and smiles. Welcome to 21st century economic development, college-town style. Meredith is a significant piece of Virginia Tech’s growing impact on greater Blacksburg. More to the point, he is part of a wider effort by community and university leaders to harness the considerable economic power of their local schools of higher education. Universities like Virginia Tech are being counted on to create more jobs in more places than ever before. In places like Blacksburg and Morgantown, W.Va., there are jobs, sure. But most of the really good ones are already under the auspices of the universities that call those cities home, and there are only so many of them. This situation tends to be most pronounced in otherwise rural towns that are home to land-grant and state universities; you don’t see nearly as much hand-wringing over retaining and recruit- Springtime on campus at Virginia Tech ing young and educated professionals in places like PHOTOGRAPHY:BOB VELTRI/VIRGINIA TECH VELTRI/VIRGINIA PHOTOGRAPHY:BOB

30 Region Focus • Summer 2005 Cambridge, Mass., Austin, Texas, and towns are also battling the basic which encompasses five counties the San Francisco Bay area. What human desire to seek out new places including the one that is home to nonurban economic developers want to live and work. Virginia Tech. “There’s a tremendous is their regions’ universities to create “Clearly, these other communities amount of talent out of these [thou- more private-sector, for-profit, off- would like to have more of Virginia sands of] students from which to campus jobs. Tech. They see it as an engine. But we develop corporations … The goal of This is a relatively new concept: In struggle to see how to do that,” says education is to train you so that you the past, economic developers in rural Ted Settle, director of the Office of can work for somebody. The problem areas were just thrilled to have all Economic Development at Virginia [in the New River Valley] is that we those college employees and students Tech. “We haven’t, I think, figured out don’t have anybody to work for.” spend their paychecks and allowances how to help those communities.” Rundgren is exaggerating for with local merchants. Now the think- effect. The employment situation in ing has changed. Classrooms are great New Twist on Town and Gown Blacksburg is relatively healthy, not for educating young people. But only The economic impact of universities dissimilar to any number of college a critical mass of good jobs, it is is well known and documented. towns — where thousands of people believed, will keep university grads In a 2001 report, the National work for the university as well-paid from fleeing the region after gradua- Association of State Universities and administrators or faculty and where tion. Equally, only large numbers of Land-Grant Colleges found that thousands of students come from out good jobs can attract accomplished member institutions provide an of town, spend their money and out-of-towners. average 6,562 jobs, not including part- tuition and indirectly fund service- Research parks have become the time student employees. Additionally, sector jobs. The number of jobs the leading solution to this problem. for every university job, another university proper creates is a simple Historically, research parks are also a 1.6 jobs are generated beyond campus, function of enrollment and research relatively new concept. The majority the survey said. Most of this impact is funding. The problem, or at least the of the 150 university research parks in the way universities have always perception of the problem, is that the now operating in the nation were helped their local economy – with farther you get away from Virginia established after 1980. The long-term students paying tuition and faculty Tech, even well within commuting vision is that these endeavors will and staff spending their money locally. distance, the farther employment spawn scores of knowledge-based jobs Virginia Tech was found to employ rates fall and the number of that spread farther from campus — to 8,038 people and generated an addi- “good” job opportunities diminish. neighboring communities whose tional 6,806 positions in the (To be sure, the New River Valley’s economic profiles pale in comparison surrounding area. Its presence was economic profile isn’t miserable, to generally prosperous college towns. said to increase Montgomery but Rundgren sees plenty of room But it’s not yet apparent that this County’s gross regional product by for improvement.) Policymakers are vision is realistic. Yes, the research $521 million, or $16,000 per house- park at Virginia Tech is such a smash hold. A more recent but different that it is drawing visitors from study put economic impact by West universities around the globe. Virginia University on the entire state Morgantown Washington, Encouraged by places like Virginia of West Virginia at $2 billion a year. D.C. Tech, Morgantown’s West Virginia West Virginia University directly pro- West Virginia University recently broke ground on vides almost one out of every three Charleston its first research park, anticipating jobs in the entire Morgantown MSA. that it will employ 2,500 workers by Increasingly, the quest for econom- Virginia 2015. (That would be almost 5 percent ic development officials in college of the Morgantown MSA’s current towns is to unlock even more value workforce.) from their resident universities. They Blacksburg Richmond At the same time, university offi- want to keep those engineering cials and local economic developers degrees from leaving. And they also acknowledge that spreading the want to recruit human capital from The cities of Blacksburg, Va., and Morgantown, W.Va., wealth beyond a core area around other places. are economically vibrant, thanks in large part to the their schools is a challenge. As much So how well is greater Blacksburg presence of Virginia Tech and West Virginia University, as the communities surrounding doing in holding onto and growing its respectively. But in these otherwise rural, somewhat college towns would like to reap more youthful and educated population? isolated communities, the economic benefits of playing benefits from the schools, the possi- “Not very,” says David Rundgren, home to a university are limited. Neighboring towns, bilities have limits. Besides the lure of executive director of the New River even those well within commuting distance, pale in good jobs elsewhere, rural college Valley Planning District Commission, economic performance by comparison.

Summer 2005 • Region Focus 31 vexed as they watch what they term working on several programs to Meredith isn’t so sure that’s feasible. “brain drain”: The university isn’t pro- create these jobs, but the biggest “Part of it is location specific, mean- ducing a critical mass of students who promise in the New River Valley ing we’re adjacent to Virginia Tech,” stay in the region after graduation. remains Virginia Tech and the he says. “It’s a chicken-and-egg Nor is it creating enough jobs to lure Corporate Research Center. “When problem. What comes first, the entre- droves of out-of-towners. we say Virginia Tech, that’s huge,” preneurs and the technologies or the Blacksburg is economically Rundgren says. “It makes a tremen- [research park] services. If you had healthy, thanks mostly to the dous difference in all kinds of services, would it attract entrepre- presence of Virginia Tech. The New activity.” neurs and technologies? I don’t know.” River Valley, which encompasses Blacksburg, isn’t faring as well, Turnaround Morgantown Takes Notice however, with unemployment at It can be slow-going starting a research By no means is Virginia Tech’s 4 percent, above the state average. park. The early years of the CRC research park an economic panacea. Personal income growth in the were not promising. Five years after But its success is the sort that has em- metropolitan area that encircles opening in 1988, thanks to a boldened other universities to start Blacksburg lags the U.S. average. $4 million contribution from the their own research parks. One of the A 2004 report by the New River Virginia Tech Foundation with most recent to get going is West Valley Planning District Commission 10 tenants and a single building, there Virginia University. described the “distressed economy of were just 20 tenants, half of which Like Blacksburg, Morgantown our region.” With an eye toward were university offices. Joe Meredith looks like an oasis of economic recently shuttered manufacturing arrived in 1993 and developed a value vibrancy when viewed on paper. plants throughout the area, planners proposition that focused on helping There is also a growing biometrics said that old-economy industries young firms grow — instead of corridor down Interstate 79 toward “can no longer provide the number of serving as a mere property manager — Clarksburg, where the FBI’s finger- jobs and spin-off companies it did and that made the difference. Today print center has helped spawn a so well in the past. We must build on there are 125 tenants representing cluster of like-minded firms. As the our local talents and strengths.” businesses that usually align with state’s leading university, however, A recent study by Virginia Tech’s Virginia Tech’s core competencies in the responsibility for driving the Center for Regional Studies found a engineering and physical sciences. new economy is keener here than at dearth of knowledge-based jobs in the Most of the employees are not univer- Virginia Tech. West Virginia ranks region and mean earnings that were sity employees, meaning these are 48th out of the 51 states and the “extremely low” compared with six new jobs that arguably wouldn’t have District of Columbia in net migration similar areas around the country existed without CRC. Tenants get of the “young, single, and college (The six compared areas were proximity to Virginia Tech and its educated.” Colorado Springs, Colo.; Fort Collins, research capabilities and easy access to Between 1995 and 2000, according Colo.; Athens, Ga.; Asheville, N.C.; a crop of young, affordable employees. to the U.S. Census, West Virginia lost Knoxville, Tenn.; and Lexington, Ky., Almost counterintuitively, the 4,691 of this group (aged 25 to 39, with all university towns in otherwise CRC until just this spring wasn’t at least a bachelor’s degree), a rate rural regions.) anything like a business incubator, in topped only by the Dakotas and Iowa. A recent survey asked students in the sense that it didn’t seek out start- By contrast, Virginia landed the New River Valley whether they up companies with no funding and no relatively high on the list, gaining were thinking about staying in the revenues. Only in April did a true 6,475 of that cohort during the same area after graduation. The report is incubator, called VT Knowledge period. But data from the Census not yet released, but Rundgren says Works, open in a new building (the Bureau suggest that the lion’s share the overwhelming majority of 18th at the park) and start helping 13 of those young and educated folks responses were negative. But when incoming startups grow their opera- migrated to Washington, D.C.’s asked whether they would stay if tions and align them with investors Northern Virginia suburbs — not to there was a good job waiting for them, and advisers. Meanwhile, Meredith is the southwestern part of the state. 98 percent switched their answer to plenty busy. He keeps clipboards on Russ Lorince, director of economic the affirmative. Rundgren certainly his desk with all his active prospects. development at West Virginia Uni- doesn’t expect that many young peo- There were 20 of them in April, all versity, says the under-construction ple to ever decide to stay in the area, real firms with revenue and a strong research park will be the highest-pro- but he takes the results to mean that interest in locating in Blacksburg. file component of the school’s effort the New River Valley would do a Several communities have to reverse the trend of poor economic much better job of keeping its kids if approached Meredith with a prop- showings. He says it’s a natural move it had more good jobs. Rundgren is osition: Build a CRC in my town. for the university, since more compa-

32 Region Focus • Summer 2005 nies are giving up costly R&D and Parks, tells to skeptics: A West Coast looking to schools to pick up the slack. university 50 years ago fretted over “It’s a tragedy to see people from your losing a stream of talented graduates region grow up and graduate from the each year to jobs in New York and local university and then go to Seattle Chicago. So the school, Stanford and Austin and San Diego, some to University, opened its own research return and many not to return,” park. Drohan says that Silicon Valley Lorince says. “So our desire is to create would not exist today were it not for opportunities for our young people Stanford University Research Park, and at the same time we create this whose famed original tenants in- stream of talent of young employees cluded Hewlett-Packard. And closer for potential employers.” to home there is Research Triangle The West Virginia research park is Park, which Drohan says “to call a expected to open around winter 2006 pipedream was an understatement.” at an initial investment of $19 million, Now, a fair amount of luck is paid for from grants and state and fed- involved with those success stories, eral agencies. Lorince expects most Drohan allows, but that doesn’t mean tenants will have ties to the university some similar sort of brushfire of inno- and its research strengths — biomet- vation can spread across West Virginia rics and forensics, advanced materials or southwest Virginia. “When you and information technology. start this momentum and create these Tom Witt, director of the Bureau new jobs that feed off each other, it of Business and Economic Research can be just like what happened in at WVU, says that land-grant univer- Silicon Valley.” sities are taking the next logical step The United States may never birth from their origins. Where their out- another Silicon Valley, but Lee Cobb reach once concentrated on aid and would settle for just a sliver of that advice to farmers and establishing kind of success. Cobb is executive branch campuses and classrooms, director of Region 2000 Economic now the mission is job creation. Development Council, which covers A recent West Virginia University graduate “There’s an increasing sense of entre- greater Lynchburg in south-central celebrates a successful college career. Here she poses preneurial activity focused on Virginia. For the past year, Cobb has with the Mountaineer statue, one of the official economic development,” Witt says. been in talks with Virginia Tech offi- emblems of the university. “With the adverse demographics that cials about setting up a tech-transfer we face in this part of southern office in Lynchburg, which is about Virginia Tech is Lynchburg’s greatest Appalachia, the development of 90 miles from Blacksburg, home to hope for appealing to a wider swath these types of institutions is one way several liberal arts colleges and sad- of workers. “To me, it’s just reality of readdressing the loss of young dled with a reputation of being a poor that kids grow up somewhere, they people.” They seek, Witt says, “a choice of location for young folks just want to go somewhere different. reverse brain drain.” starting out. That’s a challenge for us and it’s an Cobb’s group aims to get approval opportunity for us since we have A Realistic Vision? this summer and funding from the probably close to 10,000 students Expecting research parks to fix many state soon after. Without a solid link in our region,” Cobb says. “We’ve got economic woes might still strike to a research university, Lynchburg is to make those kids understand what some as naïve. But there are ardent at a disadvantage in the 21st century the opportunities are here. And believers. Here’s what William economy, Cobb says. He grants that that’s one of the things that this Drohan, executive director of the it’s only human nature to want to alignment with the university in the Association of University Research explore other lands, but he thinks city would help with.” RF PHOTOGRAPHY: DAN FRIEND/WVU PHOTOGRAPHIC SERVICES PHOTOGRAPHIC FRIEND/WVU DAN PHOTOGRAPHY:

R EADINGS “The Economic Impact of West Virginia University.” Land-Grant Colleges, August 2001. Bureau of Business and Economic Research, College of Business “Virginia’s New River Valley Regional Data Book, 2004.” and Economics, West Virginia University, June 2005. New River Valley Planning District Commission, June 2004. “Shaping the Future: The Economic Impact of Public Visit www.richmondfed.org for links to relevant sites and Universities.” National Association of State Universities and supplemental information.

Summer 2005 • Region Focus 33 From the Classroom to the So, where are the jobs? WorkPlace BY JULIA R. TAYLOR

t’s that time again. College stu- locating near each other, benefits that recently stated that the national aver- dents are graduating and looking can lead to even greater population age starting salary for a computer Ifor jobs. On the bright side, more and job growth. The Fifth District engineer is $51,496, about $20,000 than 3.1 million jobs have been created has several cities that illustrate this more than someone with a liberal arts since June 2003, an encouraging trend concept — for instance, Charlotte, degree can expect to earn. Here in for job seekers. And the demand for Raleigh-Durham, and Richmond, the the Fifth District, the numbers are skilled employees continues to rise, last of which recently joined the ranks roughly comparable, but vary across making this the best hiring period for of the nation’s 50 largest metropoli- the region, depending on the cost of college graduates since the 2001 reces- tans areas. But no metro area in the living. sion. Still, landing that first position is Fifth District seems better positioned Although the job market for recent often challenging. Many grads are for job growth than the Washington- grads is better than it was five years finding that education isn’t enough — Baltimore corridor, with its large and ago, it still takes work, career coun- employers want experience, the type growing number of service-sector jobs. selors say. When times are tough, as often gained during internships. Many students are keenly aware during the 2001 recession, people According to the Department of that some degrees are more mar- tend to go back to school — for at Labor, as of May, the national unem- ketable than others. One sophomore least two reasons. First, they may sim- ployment rate stands at 5.1 percent, from the University of Richmond ply need more education to gain an down considerably since the peak of describes her decision the following edge over fellow job seekers. Second, the most recent recession. But these way: “I need to figure out my major the “opportunity cost” of going back numbers vary from state to state. Here soon, and I don’t know whether to to school is lower, since they may be in the Fifth District, for instance, major in something I like or some- out of work already. The result: a Virginia enjoys a relatively low unem- thing that will get me a job.” larger number of skilled people in ployment rate of 3.6 percent, while But as Andy Ferguson of the the market competing for prized South Carolina’s stands at 6.3 percent, University of Richmond’s Career jobs. And this means that students according to numbers released in May Center is quick to stress, a strong lib- need to look for ways to set them- 2005. Not all jobs are created equal, eral arts education, thought by many selves apart — before they graduate. of course, and if graduates want to as not particularly practical, can pro- Even employers offering “entry- maximize their potential, they need vide many valuable job skills. “When level” positions prefer experience, to consider where the jobs are, in you start looking down the road, the such as time spent in college doing terms of both location and industry. major doesn’t matter anymore. internships or volunteering. These Not surprisingly, some industries Employers want someone who is endeavors speak to the ambition of are simply “hotter” than others. bright and motivated.” The student a student. Students also need to Nationally, demand is high for teach- who successfully completes a degree develop skills that they can build upon ers and people with health-care and in history or English will have learned and will carry over into future jobs. high-tech training. Also, the increased analytical skills through paper writing Sue Story, the director of the career emphasis on national security has and communication skills through center at Virginia Commonwealth spawned many new government giving presentations. As Ferguson University in Richmond, explains. positions, a large share of which are in explains, these are attractive qualities “What it boils down to is most or near Washington, D.C. for any candidate for any job. employers want students with experi- Ray Owens, who directs the “Students make the mistake of listen- ence. Students are realizing this in Richmond Fed’s regional economics ing to the job market too much. If the college. They’re getting internships program, says that the Fifth District only reason you get into finance is and co-ops so they can get that first is in a good position for job growth because that’s where you think the job.” So while some students about because of relatively concentrated jobs are, it is going to make you a less to graduate have completed their employment in the region’s metropoli- competitive candidate.” internships and volunteer work, and tan areas — that is, because of Still, it is hard not to be at least a have their prospective jobs in line, “agglomeration.” Simply put, there are little driven by where the jobs — and others are still sweating it out in the benefits to a large number of firms the money — are. CNN Money college career center. RF PHOTOGRAPHY: S. WANKE/PHOTOLINK/GETTY IMAGES

34 Region Focus • Summer 2005 To encourage downtown retailers to refurbish their storefronts, the Eastern Band spent more than $1 million to renovate this tribal-owned shopping complex. on the Making it Reservation

The Eastern Band of the Cherokee Indians shares the economic problems that afflict tribes nationwide and the beleaguered rural communities of western North Carolina

BY CHARLES GERENA

hether it’s Kitty Hawk or ture and history provide a compara- and ownership policies on many Virginia Beach, every tive advantage. A casino that opened reservations makes it hard to find Wtourist destination has it in 1997, one of relatively few Indian- investors for new ventures. The — a strip of retailers whose purpose is run gaming operations east of the Eastern Band is trying to meet the to empty visitors’ wallets. Downtown Mississippi, has jump-started the trib- unique challenges of life on the Cherokee in western North Carolina al economy. reservation and in western North has one too. The major difference is Across the country, the 511,000 Carolina with pragmatism and a the frequent appearance of buzzwords American Indians living on reserva- determination to survive. like “tepee” and “chief” above store- tions have struggled to succeed. Their fronts. per-capita income grew 83 percent Reservation Life On an overcast morning in April, from 1970 to 2000, outpacing the Survival was everything when the fed- the tourist season is just warming up. nationwide rate. Still, it remained eral government forced thousands of A guy stands outside of one shop about one-third of the U.S. average. Cherokee Indians from their ances- looking bored and rather chilly Median incomes, poverty levels, and tral lands throughout the Southeast dressed in Indian garb, waiting to unemployment on reservations fol- during the late 1830s. Many died dur- greet people and have his picture lowed a similar pattern — they ing the grueling westward march taken. For now, there are only a few improved significantly over the last known as the “Trail of Tears.” About couples and families wandering decade, yet still compare poorly to the 1,000 stayed behind, some hiding in around, browsing traditional crafts country as a whole. the mountains of North Carolina to sold alongside cowboy paraphernalia Economists and historians blame evade the U.S. Army. and merchandise emblazoned with this lagging performance on prob- The story of the Eastern Band “Great Smoky Mountains.” lems with financial, human, and doesn’t end there, asserts tribal mem- This is the economic heart of the physical capital; reservations either ber James Bradley. “People say, ‘Oh Qualla Boundary, the largest reserva- don’t have enough of it or use it they were removed, how sad,’ and tion in the Fifth District and home of inefficiently. Tribes have had to they don’t get a sense of how we the Eastern Band of Cherokee overcome a legacy of federal micro- fought to stay where we were and the Indians. Like its mountain neighbors management of Indian affairs, along leadership we’ve had over the years,” seeking economic opportunities, the with the present-day problems faced says Bradley, a program associate with Eastern Band has embraced tourism. by all rural communities. Further- the nonprofit Cherokee Preservation It is an industry where the tribe’s cul- more, a complicated web of land-use Foundation. PHOTOGRAPHY: CHARLES GERENA PHOTOGRAPHY:

Summer 2005 • Region Focus 35 The Eastern Band has a long history the people being governed are likely for his 50-year ground lease. of self-determination. After many to believe in and view as theirs.” Meanwhile, his efforts to develop a years of legal wrangling, tribal mem- Businesspeople dislike uncertainty, large parcel across the road haven’t bers persuaded state officials to so they are less willing to invest some- been successful. recognize their rights as permanent where that doesn’t have a legitimate, In general, researchers have found residents in 1866. This paved the way stable government which consistently that productivity is significantly for the federal government to enforces the rules of the game. higher on reservations where a rela- acknowledge their rights and for the “You’ve got to create an environment tively large portion of the land is tribe to reacquire some of its land. A [where] they feel comfortable and privately owned compared to those general council was held two years that looks promising,” notes Cornell. where land is held in trust or owned later, a new chief was elected in 1870, It doesn’t have to guarantee success, by the tribe. Part of the reason is that and the tribe incorporated under but “it has to be a place where people people may be reluctant to invest state law in 1889. are going to get a fair shake.” their knowledge and money into Today, a democratically elected The complicated nature of land making their property more produc- council serves as the legislative branch ownership has stymied economic tive if they have a hard time reaping of the Eastern Band’s tribal govern- development efforts on reservations. the added value in the future. “You’ve ment. A principal chief and vice chief Reservation land can be owned indi- got to get the incentives right,” says comprise the executive branch, while vidually by tribal members or Leonard Carlson, an Emory a tribal court serves as the judiciary. collectively by the tribe. In both University economist who has stud- The government provides basic cases, there can be restrictions on ied Indian reservations. services like sewage treatment and transferring or mortgaging property. Indeed, many business owners in police protection, as well as social Or the U.S. Secretary of the Interior can downtown Cherokee were letting services like daycare and senior hold the title to reservation land in their storefronts age, until the tribe housing, for the 8,500 tribal members trust. The Eastern Band placed its lands recently renovated its strip center and who live in the Qualla Boundary. under federal control in 1924, and other began offering low-interest loans for (About 5,000 live off the reservation.) tribes did so at other times for the same external renovations. Now, new green While the Eastern Band is a sover- reason: to keep non-Indian speculators roofs and stucco facades greet cus- eign nation with its own laws, many from snatching up Indian territory for tomers at several eateries and shops. of them are harmonized with state their gain. and federal regulations. For example, The trust arrangement has worked Rural Life everyone who works and lives in the all too well. It complicates any effort Location also works against reserva- Qualla Boundary pays a tribal levy on to obtain land or capital for new tions. The federal government often purchases that is equal to the state development. Individually owned created them on the fringes of devel- sales tax. Also, while tribal members land held in trust can be mortgaged oped areas. Therefore, they share the don’t pay a highway-use tax on vehicle only with the approval of the Interior economic challenges faced by isolated sales, they must have a valid driver’s Secretary. A non-Indian can’t pur- rural communities, challenges that limit license from the state. chase the land unless it is subject to business development to small firms and Tribal governments often perform foreclosure or cannot be transferred home-based service enterprises. many of the administrative functions within the tribe, plus any sale Remote rural areas tend to have of a county. But not every tribe has a requires federal approval. Meanwhile, higher transportation costs and long-standing, widely accepted sys- tribal land held in trust cannot be limited comparative advantages for tem of self-governance like the mortgaged or sold. While it is industry. Additionally, the mountain- Eastern Band. According to sociolo- leasable for extended periods, the ous terrain in the higher elevations of gist Stephen Cornell and other tribe and the Bureau of Indian Affairs western North Carolina leaves little researchers with the Harvard Project have to give their OK. flat land for sprawling factories, sub- on American Indian Economic Land issues were a headache for divisions, or retail centers. This Development, this is essential for Carr Swicegood, an Asheville busi- makes it hard to attract human and economic success. nessman who opened a large financial capital, which tend to “Indian nations that have taken shopping center in the Qualla migrate to where the best opportuni- over decisionmaking power—and Boundary four years ago. Swicegood ties are. It also results in insufficient have backed that power up with capa- attracted tenants like Food Lion and population density to attract and ble governmental organizations and Family Dollar to Cherokee Crossing, support large-scale service industry. structure—have done much better but banks were leery about financing As a result, the seasonally adjusted than those who haven’t,” says Cornell, the project and the development unemployment rate of western North co-director of the Harvard Project. process took longer than usual Carolina’s rural counties reached “You have to create institutions that because of the approvals he had to get 5.7 percent in April 2005 compared

36 Region Focus • Summer 2005 to 5.5 percent for the whole region and 5.3 percent for the state. This gap Lagging Incomes The three western North Carolina counties closest to the Qualla Boundary share the has persisted for the last four years. reservation’s lagging economic conditions. Still, county residents fare relatively better Meanwhile, unemployment in the than the Eastern Band of Cherokee Indians. Qualla Boundary is about 12 percent. As with many Indian reservations, State Median Household Population Below the Boundary only supports a variety Income ($) Poverty Level (%) of small employers — mostly service Eastern Cherokee Reservation 27,350 23 firms and retailers — leaving the tribe Jackson County 32,552 15 as the single biggest employer. Most Macon County 32,139 13 people work directly for the govern- Swain County 28,608 18 ment or at tribal-owned enterprises, North Carolina 39,184 12 including two gaming operations, a group of service companies operated NOTE: Data are from 1999. by the Cherokee Boys Club, and a SOURCE: U.S. Census Bureau bottled water producer. Manufacturing activity in the Qualla transportation infrastructure to These Hills” outdoor drama, a re- Boundary has dwindled from several bring people to their scenic tributary created Indian village, and two small firms to just one: a company that mass- of the Colorado River. Nor does amusement parks. produces toys and souvenirs. Most every tribe have a major metropolitan employment opportunities are outside market within driving distance and Betting on Gaming and Tourism of the reservation, such as a Stanley something to offer for visitors. Like every industry, tourism has its Furniture plant to the west. For the Eastern Band, tourism drawbacks. It pays relatively low Shouldn’t people move away to has been a good fit. Western North wages — about $7 an hour, according find better economic opportunities? Carolina is a few hours from to Sharon Blankenship of the Carlson argues that such migration Charlotte and Atlanta. The Blue Cherokee Native American Business can hinder efforts to preserve the Ridge Parkway and the Great Smoky Development Center. Then, there are unique heritage of Indian tribes. “If Mountains National Park, both just concerns about preserving the tribe’s you want a culture or language to sur- north of the Qualla Boundary, draw culture and geographic beauty that vive, you need to have a place where outdoor lovers. And one hour across many tourists pay to see. there is a concentration,” he explains. the border in Tennessee are two other The biggest downside is that Otherwise, it becomes integrated tourist magnets: Gatlinburg and tourism can be seasonal. Busloads of into the mainstream. That’s why Pigeon Forge, home of Dollywood. people fill the casino year-round, but many tribal members have stayed on The result is the plethora of road- the Indian village is open only from the Qualla Boundary or returned side shops that hawk “authentic” May to October and the outdoor home to find ways to leverage native Indian knickknacks to people head- drama only runs during the summer. skills and the region’s assets. ing toward the national park, which As a result, the unemployment rate in One asset that the Boundary has opened in 1940. One shop started by the Qualla Boundary varies from a is natural resources. In the past, it Chief Saunooke in 1939, the year that low of 6 percent in the summer to a supported agricultural activity, but the first segment of the Blue Ridge high of 35 percent in the winter. timber supplies have been depleted Parkway opened, has expanded Still, tourism brings dollars into a and families have found better ways to several times. Tribal members have community where there are few make a living than by farming. Today, made money every summer by dress- major sources of economic activity. the Boundary’s natural resources sup- ing up in Indian garb to perform for The question is whether it makes a port a different industry: tourism and shoppers outside of stores, a practice material difference in the lives of the recreation. known as “chiefing.” Eastern Band of Cherokee Indians. In general, this sector can be a Today, tourism and recreation is The answer appears to be “yes,” source of economic growth for rural the primary industry in the Qualla largely due to gaming. Similar eco- areas, as dollars come from more Boundary, accounting for 2,300 of nomic improvement has occurred in urbanized areas to communities the Boundary’s 5,500 jobs in 2003. other reservations with casinos. where traditional industries like agri- About 1,700 tourism positions are at Tribal members occupy a third of culture and manufacturing have been Harrah’s Cherokee Casino, a tribal the casino’s jobs, most of which are declining in employment. Of course, enterprise with 80,000 square feet of hourly positions that pay an average of not every Indian tribe wants its reser- video gaming devices and two 15-story just under $10 an hour. In addition, vation turned into a tourist trap — towers of luxury accommodations. businesses on the reservation get about the Havasupai Indians haven’t built Other attractions include the “Unto half of the $15 million that the casino

Summer 2005 • Region Focus 37 spends on goods and services in North The per-capita payments exceed- shops and other businesses downtown Carolina and surrounding states. ed $50 million in each of the to make them more attractive. They In addition to the economic rip- last three years, helping to boost are also working to reorient attrac- ples created by what the casino incomes and reduce poverty levels in tions to leverage the tribe’s heritage spends, the tribal government has the Qualla Boundary. The economic rather than merely offer trinkets been able to do more. Half of the net effect of these additional dollars made in China or people dressed up revenue from the casino, as well as has been more regional than local, like extras in a Western. from a tribal-owned bingo parlor, though. Without a critical mass of Once tourism is revitalized, the goes directly into the government’s year-round customers, many local tribal government will turn to the dif- coffers. Officials have used this businesses cater to the tourist trade. ficult task of diversifying the local money to expand health care and As a result, residents go outside of economy. It will do what it can to over- other services, which has required an the reservation for basic goods and come the odds, including investing expansion of its payroll to about 900 services. $1.9 million in a regional broadband employees. “You have to travel quite a dis- network to attract technology-based The other half of the tribe’s net tance to [shop],” says Michell Hicks, businesses and providing loans to gaming revenue goes to each enrolled the tribe’s principal chief. “A lot of small businesses. member as a biannual payment, which folks go to the outlet mall in Pigeon “The beauty of the natural envi- amounted to $5,200 in June 2005. Forge [or] the mall in Asheville.” ronment is probably what they should These per-capita payments accumu- Somewhat closer to home, the Wal- focus on,” suggests Todd Cherry, an late for underage members until Mart Supercenter, less than 30 Appalachian State University econo- they are 18 years old and have a high minutes away in Sylva, reportedly mist that tracks business conditions school diploma. At that point, the experiences a surge in sales every in western North Carolina. “You can windfall can be used for educational time tribe members receive their per- do some things to create a compara- purposes … or for a post-graduation capita payments. tive advantage, but you have to build spending spree. The 3.5 million people who visit on what you’re good at.” The existing the casino every year have spurred tourism sector could be expanded to Millions of visitors pass through the Eastern Band of the development of hotels and fast- include golf courses or fine restau- Cherokee’s reservation on their way to the Great food places, but the local tourist rants to appeal to different types of Smoky Mountains National Park. trade doesn’t see a lot of spillover visitors. effects. “We have two groups of peo- Regardless of how it is accom- ple that come here: the gamer and the plished, diversification will be tourist,” describes Joyce Dugan, necessary if the Eastern Band wants Harrah’s director of external relations to keep more of its dollars within the and career development at the casino Qualla Boundary. It will also help the and Hicks’ predecessor. Tourists tribe keep its young people when might spend a little money at the they graduate from high school. casino and then see other sights. In “It will be interesting to see if this contrast, gamers usually don’t ven- generation takes [their per-capita] ture into the Boundary. money and moves away, seeing other So, the tribal government is work- opportunities that are bigger than ing with the Cherokee Preservation what we have,” says Dugan. She is Foundation to revitalize the souvenir optimistic that they won’t. RF

R EADINGS Anderson, Terry Lee. Sovereign Nations or Reservations? An Economic Stambaugh, J.J. “Cherokee Renaissance: Success of Casino History of American Indians. San Francisco: Pacific Research Helping Eastern Band Reclaim Heritage.” Knoxville News/Sentinel, Institute for Public Policy, 1995. Dec. 19, 2004. Cornell, Stephen and Joseph P. Kalt. “Sovereignty and Taylor, Jonathan B. and Joseph P. Kalt. “American Indians on Nation-Building: The Development Challenge in Indian Reservations: A Databook of Socioeconomic Change Between Country Today.” American Indian Culture and Research Journal, 1998, the 1990 and 2000 Censuses.” The Harvard Project on American vol. 22, no. 3, pp. 187-214. Indian Economic Development, John F. Kennedy School of Frantz, Klaus. Indian Reservations in the United States: Territory, Government, Harvard University, January 2005. Sovereignty, and Socioeconomic Change. Chicago: University of Visit www.richmondfed.org for links to relevant sites and Chicago Press, 1999. supplemental information. Martin, Edward. “Reservations.” Business North Carolina, March 2004.

38 Region Focus • Summer 2005 ECONOMICHISTORY High Tech Down South BY DOUG CAMPBELL

t takes a good hour to tour University, and North Carolina State In the mid-1950s, Research Triangle Park (RTP) by University tentatively called Research Icar. Across this lush 7,000 acres, Triangle Park. few would have two miles wide and eight miles long, This struck Little as a superb idea. are more than 100 low-slung buildings, Even new to his job, he understood a imagined that home to some of the largest high-tech chief problem facing North Carolina’s companies on the globe. IBM, economy was that many of the science the North Carolina GlaxoSmithKline, and Cisco Systems and engineering graduates of its are just a sample of the firms employ- universities inevitably left for jobs pinelands would ing 38,000 well-paid professionals in large, often Northern cities. “I become home here. Forty-six years old, RTP is couldn’t do anything with my work in arguably the world’s premier research chemistry in North Carolina,” Little to a cluster of park, the envy of so many would-be says today at age 75. technology communities and the So Little packed his suitcase and high-tech firms, showpiece of North Carolina’s vaunt- went calling on captains of industry ed status in the New Economy. in New York. The reactions were but that was before All of which does not mask the sig- mostly positive, he recalls, but there nificant challenges facing RTP in the were no immediate takers. It was in Research Triangle 21st century. Employment here is down the summer of 1958 that Little hit pay- Park was born from the peak of 45,000 workers just a dirt when a top executive with few years ago. Many buildings are aging Chemstrand Corp. was visiting the and growing obsolete, with several sit- Chapel Hill campus on a recruiting ting vacant. In a world where U.S. firms trip for Ph.Ds. As recounted by Little can tap lower-cost sources of R&D as and by economist Albert Link in far away as India and China, the ques- Link’s A Generosity of Spirit: The Early tions about RTP mount. It is no History of the Research Triangle Park wonder that when RTP’s new presi- Chemstrand soon ditched plans for a dent, Rick Weddle, was interviewing facility in Princeton in favor of RTP. for the job about a year ago, a lot of In 1961, Chemstrand opened for friends discouraged him from taking it: business, becoming the first major “Why would you want to do that?” industrial tenant at RTP. Astroturf well-meaning colleagues asked. “Isn’t was “discovered” in Chemstrand’s lab RTP about finished?” there. The firm moved some decades later, but Little remains a fixture at Bold Vision In the summer of 1957, the idea of RTP being “finished” was the furthest thing from William Little’s mind. It hadn’t Early organizers of even started. Little was a 28-year-old, Research Triangle newly minted chemistry professor at Park gather around the University of North Carolina at a map of their Chapel Hill, a native of the state who grand plans. was looking forward to finally begin Among them was work as a teacher and researcher. Then Romeo Guest, his department chair asked Little to second from right, use the summertime on a novel pur- who is generally suit: asking companies if they would credited with consider opening shop in a non- coining the term

PHOTOGRAPHY: RESEARCH TRIANGLE FOUNDATION OF NORTH CAROLINA OF NORTH TRIANGLE FOUNDATION RESEARCH PHOTOGRAPHY: existent place between UNC, Duke “Research Triangle.”

Summer 2005 • Region Focus 39 RTP as both a member of its board of causes of human illness. UNC’s School directors and a past leader of many RESEARCH TRIANGLE PARK of Public Health, along with then- of its units and organizations. A Gov. Terry Sanford’s earlier support of Spanning 7,000 acres, Research Triangle newly constructed street looping John F. Kennedy’s presidential bid, Park is home to more than 100 research around the southern end of RTP now were believed to be key factors in the and development firms, many of which bears his name. location decision. tap the nearby resources of the three RTP would never have appeared Three months later came news that universities that make up the Triangle: on the map if not for extraordinary International Business Machines careful planning and fund-raising by Duke University in Durham, the would build a 600,000 square-foot some of the state’s leading figures of University of North Carolina in research lab at the park. IBM had been the time. Chapel Hill, and North Carolina State courted for seven years, according It began to take shape in 1954. The University in Raleigh. to Link. As Little tells it, IBM was coining of its name is credited to persuaded in part by a UNC professor, several sources but mostly to Romeo Fred Brooks, who previously had Durham Guest, a Greensboro contractor who I-85 worked as one of IBM’s top research- sketched the proposed location on a ers and developed the System/360 I-47 brown paper bag over drinks at the I-40 family of computers and Operating RESEARCH Richmond County Country Club. Chapel TRIANGLE System/360 software. IBM today Legend has it that Guest noticed how Hill PARK remains RTP’s largest employer, with

UNC, Duke, and N.C. State formed Raleigh 11,000 workers at its campus. a sort of sideways triangle. Link’s After IBM and NIEHS, 21 more A Generosity of Spirit relates a March companies located in the park by 1969, 1954 meeting with Guest, Wachovia followed by 17 more in the 1970s, Bank President Robert Hanes, and SOURCE: Research Triangle Foundation of 28 more in the 1980s and a booming North Carolina Treasurer Brandon North Carolina 42 organizations in the 1990s. Hodges whose stated purpose was the Employment leaped to more than need for industrial growth but turned second was Archie Davis, who succeed- 30,000 by 1990. The Triangle Univer- into Guest’s pitch for Research Triangle ed Hanes at the helm of Wachovia and sities Center for Advanced Studies, Park. A year later, Gov. Luther Hodges raised $1.25 million in just 60 days to known around campus as TUCASI, was (no relation to Brandon) established buyout Robbins in 1959. About 20 per- set up in 1975 by the RTP Foundation the Research Triangle Development cent of the funds came from the for the explicit purpose of keeping the Council, which quickly became the Raleigh-Durham-Chapel Hill area, but three universities working together. Research Triangle Committee. the rest were from donors scattered Late that same year, the American In a description that holds up to across the state, all anonymous at the Academy of Arts and Sciences agreed to this day, Hodges once described the time. Pinelands became the Research locate the National Humanities Center committee’s vision for RTP as en- Triangle Foundation, which endures on the TUCASI campus. compassing three things: the actual today as the park’s administrator. tract of land, the three universities Chemstrand was a significant addi- An Unparalleled Success themselves, and “… an idea that has tion, as was the official first tenant, the Today all but 1,100 acres of the 7,000- produced a reality — the idea that Research Triangle Institute, a contract acre park are developed. There are the brains and talents of the three research group. But between 1960 and some 120 research organizations and institutions, and their life of research 1965, no other big fish were landed, and companies. There are 13 miles of paved in many fields, could provide the back- people started to whisper about the jogging trails and a “town center” with ground and stimulation of research for park’s prospects for survival. “There banks, restaurants, and a hotel. The the benefit of the state and nation.” was skepticism and paranoia,” Little park requires organizations to build says, summing up the local mood. on only 15 percent of their total prop- Laying the Foundation By 1965, the skepticism was history erty with wide setbacks from the Between 1957 and 1959, the park’s jour- thanks to two enormous recruiting street, making the area seem almost ney from dream to reality was driven by wins. The first was what became bucolic, with buildings hidden from two key businessmen. The first known as the National Institute of the roadway. The total park payroll is was Karl Robbins, a New York indus- Environmental Health Sciences estimated at $2.7 billion, making the trialist who agreed to put up $1 million (NIEHS), which RTP agents had been average salary about $56,000. to acquire land in what became RTP, pursuing for four years. The project, Nobody accused former UNC eventually amassing 3,559 acres he announced in January 1965, was valued System President Bill Friday of exag- outright controlled or had options to at $70 million and remains the nation’s geration when he said: “Research under the name “Pinelands Co.” The center of studying environmental Triangle Park is the most significant

40 Region Focus • Summer 2005 economic and political manifestation RTP’s favor: “dedicated people, three up each and every single day thinking of will in the state in the last century.” outstanding universities, and a world- about how to add value to a defined set Such is the park’s cachet that firms as class research institute.” But to Link, of companies,” Weddle says. far as 30 miles away have claimed RTP the key is the presence of the research University access is by no means the post office boxes so they can put institute TUCASI — without it, an exclusive right of RTP tenants, but the “Research Triangle Park” and its famed official forum for the three universi- park remains a central hub for inter- 27709 ZIP code on their letterhead. ties to cooperate wouldn’t exist. action among UNC, Duke, and N.C. (Equally, many firms just outside the It is the convergence of the three State, and the university presidents sit official park borders still call them- schools, the combining of their talents on the RTP Foundation board. selves RTP tenants, and they have and resources, that has propelled RTP Weddle sees an RTP where none of become a de facto part of the wider to the top, Link believes. “There is one the workers have to drive on Interstate Research Triangle community.) A ten- unique aspect of the infrastructure of 40 to get to their offices, because ant tells the story of visiting Germany the park unrivaled by any park in this they’ll be able to ride a high-speed rail recently and telling the host that his country, and that is TUCASI.” into the park and walk the rest of the organization had recently located in way. He sees residential development, North Carolina. The host nodded The Future for the first time, inside park borders, knowingly and said: “Yes, we know The present-day state of RTP also along with new retail options. But the about North Carolina. It’s in the contains some troubling signs: old, focus is shifting from just selling land Research Triangle Park.” vacant buildings and an economy that to “harmonizing the knowledge assets RTP’s wider economic impact is no longer seems to favor geographic in the region,” which means throwing hard to overstate. In a 1999 report, clusters the way it used to. Which the weight of RTP — the brand — a consulting firm estimated that more brings us back to Rick Weddle, beyond park borders and across its than $300 million of private invest- who took over the job of RTP presi- wider sphere of influence. ment was generated in plants in the dent after his predecessor, Jim The payoff, Weddle says, will be 10 counties surrounding the Triangle Roberson, retired in July 2004. When that the park can grow so that it during the 1990s. Employment in people ask him, “Isn’t it about fin- employs as many as 90,000 people “new line, technology-related” indus- ished?” Weddle is adamant in his under current density rules; should tries grew from 15 percent of all jobs response: “The reality of the matter is those rules be loosened, as many as in the region to almost half by the end it is just now beginning.” 150,000 jobs are envisioned. Weddle of the 20th century. Here is what Weddle is selling: RTP wants to steer RTP from being known The precise reasons RTP succeed- is not in a city; its area is 75 percent in as solely the home of large-facility, ed while so many other similarly aimed Durham County and 25 percent in multinational organizations to one projects have faltered remains a bit Wake County. Thus, landowners don’t having a portfolio of diverse firms, of a mystery. The timing was good, pay municipal property taxes, just spanning industries and sizes, from with Sputnik’s orbit in 1956 having those of the county. They are also startups to mature cash cows. sparked government enthusiasm for members of the park’s owners and It sounds incredible. The only research. The advent of air condition- tenants association, which is like a big thing keeping people form guffawing ing also made year-round working in homeowners association that helps at Weddle is the position from where the South more practical and comfort- manage growth. Tenants are part of a he sits. There remains nothing else able. RTP wasn’t the first research special tax district whose rate is about quite like Research Triangle Park. So park — Stanford Research Park, for 2 cents per every $100 of property val- Weddle feels perfectly justified in say- instance, was founded in 1951 — but it uation — adding, for example, $2,000 ing things like: “I’m excited and was one of the first, and as such to the annual tax bill for a firm with a optimistic because I still see most of achieved crucial “first-mover” advan- $10 million lab. The RTP Foundation, the world trying to copy the way we tage over would-be competitors. which is funded chiefly by the land liq- were. That gives us the opportunity In his histories of the park, Prof. uidations valued at $3 million annually, to begin to develop the way we’re going Link cites three obvious factors in is a service unit whose job is “to wake to be.” RF

R EADINGS Link, Albert N. A Generosity of Spirit: The Early History of the Luger, Michael I., and Harvey A. Goldstein. Technology in the Research Triangle Park. Research Triangle Park, N.C.: Research Garden: Research Parks and Regional Economic Development. Chapel Triangle Foundation of North Carolina, 1995. Hill, N.C.: University of North Carolina Press, 1991.

__. From Seed to Harvest: The Growth of the Research Triangle Park. Visit www.richmondfed.org for links to relevant sites. Research Triangle Park, N.C.: Research Triangle Foundation of North Carolina, 2002.

Summer 2005 • Region Focus 41 INTERVIEW Robert Whaples

Editor’s Note: This is an abbreviated version of RF’s con- RF: I want to ask a few questions about your 1995 article versation with Robert Whaples. For the full interview, go to in the Journal of Economic History, “Where Is There our Web site: www.richmondfed.org Consensus Among American Economic Historians? The Results of a Survey on Forty Propositions.” In some areas, there is general agreement among the profession- Economists are sometimes accused of being al economists and the professional historians polled, more interested in high theory than in explaining while on others there is a pretty sharp division. Were you real-world events. This may be correct in select surprised by this? cases, but it’s questionable as a general proposi- Whaples: I was not surprised by the differences that I tion. And when it comes to economic historians, found. I was more surprised by how much agreement there the opposite is probably closer to the truth. was between the two disciplines. I spent the first few years Their research seeks to explain how and why of my career teaching in a history department, and I found things developed over time, and to do so they that many historians have little understanding of or appre- ciation for how markets work. This is in contrast to employ the tools not only of modern economics economists. Even those economists who are inclined to but also of many related disciplines. believe that the government has an important role to play in the economy still tend to think that people are rational Economic historian Robert Whaples of Wake actors and that markets are generally efficient. So I thought that the divergence between economic historians who were Forest University is no exception. His research trained principally as historians and those who were trained on labor markets, for instance, examines the principally as economists would be larger than they were. economic, political, social, and ideological factors that shape the way Americans work. He also has written a number of papers that explore where there is consensus among economic historians and where there is significant disagreement.

Whaples has received two major awards from the Economic History Association. In 1990, he was awarded the Allen Nevins Prize, given annually to the best doctoral dissertation in the field of American and Canadian economic history, for his work on the shortening of the workweek. And in 1999, he won the Jonathan Hughes Prize for Excellence in Teaching Economic History. In addition, Whaples is director of EH.Net, which provides extensive online resources for economic historians and students.

Aaron Steelman interviewed Whaples on the

Wake Forest campus on May 23, 2005. UNIVERSITY FOREST KEN BENNETT/WAKE PHOTOGRAPHY:

42 Region Focus • Summer 2005 RF: More than half of the economists polled disagreed RF: Following the Civil War, it took a significant amount with the proposition that “monetary forces were the of time for the Southern economy to converge to primary cause of the Great Depression.” Why do you Northern levels. There have been several ideas offered to think there is a probable disconnect on this issue between explain why that was the case. Which explanation, or com- economists who specialize in bination of explanations, do you monetary issues — most of whom find most convincing? would likely answer that question There are some in the affirmative — and econ- Whaples: At the time the Civil omic historians? New Deal programs that War began, the South was not behind the rest of the country Whaples: My sense is that econom- many economic historians economically, but afterward, living ic historians are likely to have done standards were well below those more extensive reading about that see as major blunders. in the North. The question is: time period and the very complex Why? Many parts of the South nature of the phenomenon. They were decimated by the war, and the wouldn’t deny that monetary forces were very important, destruction of capital certainly played a role. But this does but they are likely to consider all of these other things that not explain why things took so long to turn around. The were going on. So it may largely be a semantic issue, with the abolition of slavery was certainly important. Freed slaves economic historians less likely to describe anything as the decided to work less and consume more leisure. Also, the “primary cause” of the Great Depression, because they price of cotton was near an all-time high before the war but attribute it to a constellation of events. then declined for most of the rest of the century. So that hurt the South’s economy and is part of the story. RF: Staying on the topic of the Great Depression, the My favorite interpretation of what happened following economists polled were significantly more likely than the Civil War, and I think it’s probably the profession’s the historians to agree that the “New Deal served to favorite interpretation, is pretty akin to what Gavin Wright lengthen and deepen” the economic problems of the late has argued in Old South, New South. It emphasizes the 1920s and the 1930s. What is your view on this question? lack of integration, especially in the labor market and also in the capital market. Whaples: First, I should say that it is a very provocative Labor really did not come out of the South, mainly for question, and it elicited an interesting response. The finding cultural reasons and perhaps for some economic reasons. was almost an even split among the economists polled. Capital was less willing to come into the South, partly Forty-nine percent either agreed, or agreed with provisos, because at this time you often needed to have the managers that the New Deal “served to lengthen and deepen the Great migrating with the capital, and many were unwilling to do so. Depression,” while 51 percent disagreed. So there’s a large One reason was climatic: This was before the invention of air- share of economists who think that the New Deal wasn’t conditioning. Another was cultural: We just don’t like the way such a good deal. they do things down here and we’re not really well accepted. Why? There are some New Deal programs that many I have stated the story in pretty crude terms, but that’s the economic historians see as major blunders. At the top of the flavor of the argument, and I think it’s pretty persuasive. list is the National Industrial Recovery Act, which cartelized the economy just as it was getting off the ground, leading to RF: But wouldn’t we expect capital to flow to where the lower output, consumption, and employment. If you look at returns are the highest, even if there are some cultural the quarter-by-quarter estimates — they’re not perfect, but institutions in the South that Northern investors find they do shed some light on this time — by 1933 the economy unappealing? was starting to come back pretty rapidly. Then the NIRA was passed, and by the last quarter of 1933, the economy Whaples: I think that there are clearly some examples of started to go down. this. If the return on capital was high enough, it did move to There are other programs that many economic historians the South. Take the region around Birmingham, Ala., for look at critically. They may have had some desirable effects, instance. There were some very good iron deposits around but probably slowed down the recovery. One is the Wagner that area, which made it a natural place for steel production. Act, which led to the sit-down strikes and labor unrest. The textile industry moved to the Carolinas, largely from Another is the Social Security Act, which increased the tax New England, New York, and New Jersey. But in marginal burden when many people believed that a fiscal stimulus was cases, where the returns were likely to be similar to those in needed. By 1937 the economy really slowed down again, lead- the North, capital didn’t tend to flow south. ing to what has been called the “Roosevelt recession.” So many Also, I would like to make a more general point about the economic historians believe that there were a number of mis- economy of the post-bellum South. There are some very steps taken during the New Deal, and I would tend to agree. important regional differences. Prior to the Civil War, the

Summer 2005 • Region Focus 43 poorest part of the South is where norm in the United States? And we are today: North Carolina. And what were the principal causes the richest parts were the cotton of this change? areas near the Mississippi Delta. Now, that situation is essentially Whaples: The best documentation reversed. we have about the length of the workweek comes from the manu- RF: Nearly everyone you polled facturing sector. In the mid-19th disagreed with the proposition century, the workweeks were very that “the slave system was eco- long. But then they came down fairly nomically moribund on the eve of rapidly. By the end of World War I, the Civil War.” Had the South we effectively had the eight-hour been permitted to secede in 1861, day. It wasn’t quite in the form that how long do you think slavery we recognize today, because the would have remained economic- workweek was generally six days. ally viable? That stayed the norm until the Great Depression, when a lot of Whaples: This is pretty interesting. Saturday work ended. Work sched- The belief that slavery was on its ules became considerably longer way out prior to the Civil War was widely respected and during World War II. But in the main, the typical workweek accepted for a long time — from the end of the Civil War has been five eight-hour days since the 1930s. So it did come until the 1950s or so. But since then, more rigorous models sooner than many people think, and it did predate the Fair have shown that the returns that slaveowners received were Labor Standards Act, which gave us the overtime law in 1938. pretty large. So if you are looking at it purely from an eco- My research on this topic strongly suggests that the nomic standpoint, it’s hard to say that the system was cause of the shorter workweek was economic growth, moribund. which led to higher real wages. But I think we have to put How long would slavery have lasted had the Civil War not that answer into the context of the time in which it occurred? I began to think about that, and all you really need occurred, because we have had substantial growth in real is a system in which the marginal revenue product of labor wages since then, yet we haven’t seen the length of the is high enough to cover the maintenance cost. A slaveowner workweek go down even more. would have approached this question in the same way that So what was occurring during the late 1800s and early he would have considered the issue of using mules and 1900s? I think it had to do with the marginal utility of an horses following the invention of the automobile. When the extra hour of leisure being incredibly high during that peri- automobile and tractor came along, using draft animals was od. Many people were doing pretty onerous work. There no longer economically viable, and so many owners just were many mind-numbing routine jobs and many jobs that let those animals go. That’s a system that is moribund. required back-breaking physical labor. But we don’t have a Would that have happened in the human system? I don’t great number of those jobs in our economy any longer. In think so. Human beings are so much more flexible and fact, a lot of us have jobs where the distinction between adaptable that slaves could have been put to many other work and leisure gets a little fuzzy. Well, it wasn’t fuzzy uses once the cotton industry had become mechanized and back then, and boy, did they want those extra hours off to people were no longer needed in large numbers. In fact, relax, spend time with their families, and hang out with the we know that before the Civil War there was a lot of indus- guys. So as wages got higher, they bought more of this trial slavery. Slaves were moved from farms to factories as leisure time. Any other economic factor is so secondary to the latter became more profitable. I think that would have this that I don’t even think it’s worth mentioning. continued to be the case, with slaves being used in a variety Also, I think it’s worth mentioning that although the of agricultural, industrial, and even service-sector jobs. workweek hasn’t gotten shorter in recent years — in fact, So, economically, I think slavery could have remained for more educated and skilled workers there is some evi- viable for a very long time after the Civil War. What would dence that it has gotten longer — the total share of a have probably undermined the system was the reduced cost person’s life spent working for pay has continued to fall. of transportation and communication. As it became cheaper People enter the labor force at later ages, they retire earlier, and easier to escape from bondage, the costs of monitoring and they live longer. All of these things have contributed to slaves probably would have become prohibitively large. more leisure consumption.

RF: You have done a lot of work on labor issues, specif- RF: Why do you think that the South has traditionally ically questions having to do with the length of the had a smaller share of its labor market unionized than workweek. When did the eight-hour day become the the North?

44 Region Focus • Summer 2005 Whaples: Whenever I teach labor economics, I pull out meeting in 1996, where we chartered ourselves as a new data on unionization rates from the Bureau of Labor organization, with Samuel Williamson of Miami University Statistics. And it’s always a battle between North Carolina as the director and myself as the associate director. Our divi- and South Carolina for who has the lowest share. sion of labor was the following: Sam was the fund-raiser and Unionization rates have always been lower in the South principal organizer, and I focused on adding content to the than in the rest of the country. One explanation is the nature Web site. of the region’s economy: Agriculture has traditionally been There are several things that we offer. Perhaps the most more important to the South, and that sector typically has important is our “How Much Is That?” feature, which allows pretty low unionization rates. Going beyond that, I think people to obtain historical data on inflation rates, exchange there are some important cultural factors. When unions are rates, economic output, the cost of labor, purchasing power, really strong, there is a sense among workers that it’s us ver- and a number of other data series. We also have an encyclope- sus them, labor versus management. In the North, the dia that is aimed at students and lay readers. The entries workers were often a group of immigrants, while the man- discuss the big issues in economic history — slavery, the Civil agement was often the native-born, better-educated elite. In War, and the Great Depression, for instance — as well as more the South, there was much less of that. The division was offbeat topics like prohibition and Major League Baseball. black versus white, and culturally the white workers identi- There are about 100 articles in the encyclopedia, and the fied with management. So there was much less of an idea is to get the research that is published in the profes- us-versus-them mentality. That, I think, has a lot to do with sional journals out there to the public. So much of it is holed the relative weakness of labor unions in the South. up in academic libraries, when we think there is a much broader audience for it. The other RF: You have co-edited a book big thing we have is a book review titled Public Choice Interpretations Robert Whaples section. We now have reviewed of Economic History. What insights about 1,000 books over the years. ➤ Present Position can public choice bring to bear on Most of them have come through economic history? Professor of Economics, Wake Forest my office, and we try to be compre- University, and Director of EH.Net hensive in our coverage. We aim to Whaples: I think the best way to ➤ Previous Faculty Appointments review everything that is published answer that question may be to dis- Department of History, University of in the core areas of economic histo- cuss my favorite chapter from that Wisconsin-Milwaukee (1988-1991) ry, and many books that are in more book. Werner Troesken of the peripheral areas. ➤ Education University of Pittsburgh looks at the As for the organization, in 2003 passage of the Sherman Antitrust B.A., University of Maryland (1983); Ph.D., the Economic History Association Act. He analyzes what happened to University of Pennsylvania (1990) became the owner of EH.Net. Also, I the stock prices of the big trusts at ➤ Selected Publications became the director that year, the time. What he shows, pretty con- Author of several articles in the Journal of though Sam Williamson is still quite vincingly, is that the value of those Economic History and other academic jour- active. And I’m proud to say that my companies’ stocks were rising as it nals, and co-editor of two books, Historical son, Thomas, who is a student at became more and more certain that Perspectives on the American Economy (1995) Wake Forest, is EH.Net’s webmaster. the Sherman Antitrust Act was going and Public Choice Interpretations of American to be passed. So the markets clearly Economic History (1999) RF: Which economists have influ- thought that the law was going to be enced you the most? good for the very companies whose power, ostensibly, it was designed to curb. That might seem pretty counterintuitive to Whaples: Probably the economist who has influenced me many, but it’s an interpretation that a public-choice econo- the most is Gary Becker. By applying the assumption that mist would find pretty intuitive. individuals are rational and utility-maximizing to areas once thought beyond the scope of economics, he has helped us RF: Please tell our readers a little bit about EH.Net and better understand so many facets of life. Among economic your role in it. historians, Robert Fogel is probably the most influential. His relentless quantification, his willingness to be so inter- Whaples: EH.Net grew out of the Cliometric Society. It disciplinary in his work, and his extreme optimism are started as an online discussion group among members of the things that I find extremely admirable. Closer to home, the Society in 1994, in the early days of the Internet. We found people on my dissertation committee — Claudia Goldin, that this was useful, but we wanted to make it more perma- Robert Margo, and Paul Taubman — have been very impor- nent. And we thought that the way to do that was to make it tant to me. Also, I should note Gavin Wright and Joel an independent organization, and one that offered a lot Mokyr. When I read them, I learn more about how to be an more than a simple online discussion forum. So we held a economic historian. RF

Summer 2005 • Region Focus 45 BOOKREVIEW The Relentless Pursuit of Incentives

FREAKONOMICS: A ROGUE ECONOMIST EXPLORES Such puzzles — why a homeless man would have $50 THE HIDDEN SIDE OF EVERYTHING headphones, for example — are the type of thing that inter- BY STEVEN D. LEVITT AND STEPHEN J. DUBNER ests Levitt. And presumably those eclectic interests are what NEW YORK: WILLIAM MORROW, 2005, 242 PAGES intrigued Dubner and the New York Times Magazine about Levitt. He doesn’t try to answer sweeping macroeconomic REVIEWED BY AARON STEELMAN questions or offer an opinion on where the economy is head- ing in the next year. In fact, if you were to ask him about t’s rare that a book on economics makes the best-seller such topics, he would probably say that your guess is as good lists. But Freakonomics: A Rogue Economist Explores the as his. Instead, Levitt has made a name for himself through IHidden Side of Everything by Steven Levitt and Stephen careful empirical examination of microeconomic questions. Dubner has been there for several months and shows no signs of leaving. Unusual Topics, Conventional Methods Levitt is an economist at the University of Chicago who Many of those questions might seem beyond the scope of in 2003 won the John Bates Clark Medal, given every economics. But as Levitt and Dubner write, “the science of two years to the top American economist under the age of economics is primarily a set of tools, as opposed to a 40. Dubner is a journalist, who wrote a profile of Levitt in subject matter,” and this means that “no subject, however the New York Times Magazine the same year. That article offbeat, need be beyond its reach.” Fine, you might say. began with the following passage: Still, aren’t some of those offbeat subjects — such as why The most brilliant young economist in America — the one so African-American parents often give their children distinc- deemed, at least, by a jury of his elders — brakes to a stop at tively “black names” — frivolous compared to more a traffic light on Chicago’s South Side. conventional topics of economic inquiry? That’s a judgment It is a sunny day in mid-June. He drives an aging green Chevy call. But looking at seemingly frivolous topics can help us Cavalier with a dusty dashboard and a window that better appreciate the role of incentives, which Levitt and doesn’t quite shut, producing a dull roar at highway speeds. Dubner rightly claim are “the cornerstone of modern life. But the car is quiet for now, as are the noontime streets: And understanding them — or, often ferreting them out — gas stations, boundless concrete, brick buildings with plywood is the key to solving just about any riddle.” windows. Indeed, if there is a unifying theme to Levitt’s work, An elderly homeless man approaches. it’s the belief that incentives guide It says he is homeless right on his sign, individual people’s lives and in the which also asks for money. He wears a process shape the course of society. torn jacket, too heavy for the warm day, Levitt is not unique in this way. All and a grimy red baseball cap. economists think that incentives The economist doesn’t lock his doors matter. But Levitt is relentless in or inch the car forward. Nor does he go the application of this principle, scrounging for spare change. He just and that has led him to some watches, as if through one-way glass. controversial conclusions. After a while, the homeless man moves along. Safer Cities “He had nice headphones,” says the Before the publication of economist, still watching in the Freakonomics, Levitt was probably rearview mirror. “Well, nicer than the best known for his work on the ones I have. Otherwise, it doesn’t look declining crime rates of the 1990s, like he has many assets.” research that he and Dubner Steven Levitt tends to see things discuss in Chapter 4 of the book. differently than the average person. At the beginning of that decade, Differently, too, than the average econo- violent crime was wreaking havoc mist. This is either a wonderful trait or in America’s cities, and many a troubling one, depending on how you social scientists and policymakers feel about economists. claimed that things were only going

46 Region Focus • Summer 2005 to get worse. As late as 1997, with crime rates already on a ethically wrong. Nor does it mean that you have to argue steady downward trend, President Clinton warned that that every child born into a dysfunctional household will “we’ve got about six years to turn this juvenile crime thing become a criminal. Indeed, most of us probably know cases around or our country is going to be living with chaos. to the contrary. What accepting this argument does And my successors will not be giving speeches about the require, though, is an openness to scientific inquiry, wonderful opportunities of the global economy; they’ll be no matter where the data may lead you. Levitt and Dubner trying to keep body and soul together for people on the write: “Morality, it could be argued, represents the way that streets of these cities.” people would like the world to work — whereas economics Fortunately, this dire prediction did not come to pass. represents how it actually does work.” Crime rates in the United States continued to fall sharply, and That idea is on display throughout the rest of the instead of writing about the emergence of “superpredators,” book, as the authors examine a host of other questions. the media focused its attention instead on how some of For instance, they discuss why school teachers may help America’s once-doomed cities — their students cheat on standard- New York, in particular — had ized exams, and how administrators become much safer places to live. The can tell when this is happening. suburbs, which had once been seen as Economics is primarily a They consider whether a real estate a safety valve for parents too afraid to agent can be expected to act in a take their kids to Central Park, were set of tools, as opposed home-seller’s best interest. And now viewed by many commentators they dissect the internal organiza- as a scourge. Within just a few years, to a subject matter. tion of a drug-selling gang. the media went from lamenting the Nearly all of the topics in the perils of America’s urban centers to — STEVEN LEVITT AND STEPHEN DUBNER book come from articles that Levitt criticizing suburban sprawl. wrote for professional economic What led to the decline in crime journals. Those articles have been rates? According to many of the social scientists and policy- reworked for a nontechnical audience, but remain true to the makers who earlier had predicted that we were on the cusp original ideas. In short, Levitt and Dubner faithfully present of an urban apocalypse, it was a confluence of three factors: the logic, while eschewing the math. a growing economy; tougher policing, including a “no-toler- ance” policy for many lesser crimes; and more restrictive What’s in a Name? gun-control laws. All three were plausible explanations. Which brings me to the title — Freakonomics: A Rogue And all were things for which the social scientists and poli- Economist Explores the Hidden Side of Everything. Many cymakers were happy to claim credit; it was their ideas, they economists have criticized this choice. How, they ask, said, that finally brought crime under control. could Steven Levitt, winner of the John Bates Clark Medal, But when Levitt looked at the data, he doubted the possibly be considered a “rogue” economist? After all, it’s importance of those oft-cited factors. They may have been one of the most prestigious prizes in the profession, and part of the story, but he argued that there was a much more many past winners have gone on to win the Nobel Prize. important factor behind the drop in crime: legalized Levitt, they say, is anything but an outsider. abortion. In January 1973, the Supreme Court issued its deci- These critics are both right and wrong. It is a misleading sion in Roe v. Wade. Afterward, abortions were much easier title. The topics Levitt chooses may be unconventional, and cheaper to obtain in the United States. but his methods are certainly mainstream. At bottom, he is What does this have to do with falling crime rates? a neoclassical economist — no doubt a uniquely talented Think of it as a three-step process. First, children from one, but this doesn’t lend him rogue status. Also, at points dysfunctional households are more likely to become throughout the book, the authors talk about freakonomics criminals. Second, those women who had foregone illegal as a “field” of study. But it’s not. What Levitt does is use abortions because of their expense were more likely to microeconomics to answer interesting questions. That hard- come from dysfunctional households. Third, following ly makes for a new field, a point the authors admit when they Roe v. Wade, many of the women who before would have argue that economics is about the tools that its practitioners given birth ended their pregnancies instead. The result, use, not the topics they choose. according to Levitt and Dubner, is that “the pool of Still, it’s hard to be too critical of the title. It almost potential criminals had dramatically shrunk.” So by the mid- certainly has made the book easier to market, resulting in 1990s, “just as these unborn children would have entered more copies being sold and Levitt’s ideas being presented to their criminal primes, the rate of crime began to plummet.” a wider audience. Hopefully, some of those readers will For people who believe that abortion is evil, this may be discover that economics is not such a dismal science — that a difficult conclusion to accept. But in this case, acceptance it offers powerful ways to look at the world in all its dimen- doesn’t mean approval. One could accept Levitt’s argument sions. If so, the costs of the book’s misleading title surely will as an empirical truth while still believing that abortion is be outweighed by its benefits. RF

Summer 2005 • Region Focus 47 DISTRICT ECONOMIC OVERVIEW BY ROBERT LACY

he Fifth District economy District Gains Jobs expanded at a fairly strong The Fifth District Despite the loss in manufacturing T pace in the first quarter of jobs, first-quarter payroll employ- 2005. Services businesses generally economy expanded at a ment in the Fifth District was 1.4 reported solid gains in revenues, percent higher than a year ago. This manufacturers said that shipments relatively strong pace was slightly off the pace of the sec- and new orders were up (albeit ond half of 2004 and somewhat modestly in some cases), and in the first quarter short of the rate of expansion employment and personal income nationwide. Slow employment rose in District states. Although of 2005, but growth in South Carolina account- growth in output and employment momentum slowed ed for some of the difference in the services sector slowed between the U.S. and the District’s toward the end of the quarter, by the end of growth rates. South Carolina pay- the District economy retained roll employment rose by a meager considerable momentum heading the quarter. 2,200 jobs year over year, and jobs into the spring. in the health services and education sector fell compared to a year ago. Growth Continues higher gasoline prices contributed to The unemployment rate in the Services businesses generally report- March’s malaise. District edged lower — from 4.9 per- ed higher sales and expanded payrolls Manufacturing output rose in cent to 4.8 percent in the first in the first quarter. Home sales and the first quarter, but the pace of quarter. Virginia’s unemployment residential building activity were expansion remained generally mod- rate dipped to 3.3 percent, among the particularly brisk, and commercial est. New orders and shipments were lowest rates in the nation. Rates of real estate activity picked up in a somewhat higher while capacity unemployment in Maryland, North number of areas. Financial institu- utilization was flat. Manufacturing Carolina, and West Virginia were rela- tions reported higher lending activity employment, on the other hand, tively low as well, and below the U.S. as well. edged lower; 16,000 jobs were average of 5.3 percent for the quarter. Retail sales, however, were a little trimmed from payrolls in the first softer in the first quarter. Shopper quarter. The textiles and apparel Energy Prices Jump traffic and sales growth began to slow sectors, which employ one in seven of Higher energy prices filtered through in February, and by March an in- the District’s manufacturing workers, the Fifth District economy in the first creasing number of retailers were will likely contract further in 2005 as quarter. Manufacturers, public utilities, reporting stagnant sales. Retailers imports are expected to gain even and transportation firms in particular said rainy weather and substantially greater shares of the U.S. market. endured substantially higher energy costs during the period. Businesses with little pricing power, especially tex- Economic Indicators tiles and apparel firms, saw their profit 1st Qtr. 1st Qtr. Percent Change margins squeezed as higher petroleum 2005 2004 (Year Ago) prices raised raw materials costs. Other firms were able to pass at Nonfarm Employment (000) least some of their higher energy Fifth District 13,262 13,074 1.4 U.S. 132,822 130,541 1.7 costs on to their customers. Real Personal Income ($bil) Consumers throughout the District Fifth District 885.4 844.6 4.8 grumbled as gasoline prices rose U.S. 9,232.7 8,838.9 4.5 above $2.00 per gallon at the pump in Building Permits (000) the first quarter. According to the Fifth District 57.9 54.0 7.2 consumer price index for the U.S. 469.2 442.4 6.0 Washington, D.C.-Baltimore metro- Unemployment Rate (%) politan area, energy prices in March Fifth District 4.8% 5.1% 2005 were 14 percent higher than a U.S. 5.3% 5.7% year earlier.

48 Region Focus • Summer 2005 Nonfarm Employment Unemployment Rate Real Personal Income Change From Prior Year First Quarter 1992 - First Quarter 2005 Change From Prior Year First Quarter 1992 - First Quarter 2005 First Quarter 1992 - First Quarter 2005 4% 8% 8% 3% 7% 7% 6% 2% 5% 6% 4% 1% 5% 3% 0 2% 4% 1% -1% 0% -2% 3% -1% 1992 1995 1998 2001 2004 1992 1995 1998 2001 2004 1992 1995 1998 2001 2004 Fifth District United States Nonfarm Employment Unemployment Rate Building Permits Metropolitan Areas Metropolitan Areas Change From Prior Year Change From Prior Year First Quarter 1992 - First Quarter 2005 First Quarter 1994 - First Quarter 2005 First Quarter 1992 - First Quarter 2005 8% 9% 30% 7% 8% 6% 20% 5% 7% 4% 10% 3% 6% 2% 5% 1% 0% 0 4% -1% -10% -2% 3% -3% 2% -20% 1992 1995 1998 2001 2004 1992 1995 1998 2001 2004 1994 1996 1998 2000 2002 2004 Charlotte Baltimore Washington Charlotte Baltimore Washington Fifth District United States

FRB—Richmond FRB—Richmond Washington DC—Baltimore Metro Services Revenues Index Manufacturing Composite Index Area Consumer Price Index First Quarter 1994 - First Quarter 2005 First Quarter 1994 - First Quarter 2005 January 1997 - March 2005 All Items 40 40 150 Energy 30 30 140 20 20 130 10 10 120

0 0 110

-10 -10 100 -20 -20 90 -30 -30 80 1994 1996 1998 2000 2002 2004 1994 1996 1998 2000 2002 2004 1997 1998 1999 2000 2001 2002 2003 2004 2005

NOTES: SOURCES: 1) FRB-Richmond survey indexes are diffusion indexes representing the percentage of responding firms Income: Bureau of Economic Analysis, U.S. Department of Commerce, http://www.bea.doc.gov. reporting increase minus the percentage reporting decrease. Unemployment rate: LAUS Program, Bureau of Labor Statistics, U.S. Department of Labor, The manufacturing composite index is a weighted average of the shipments, new orders, and employment http://stats.bls.gov. indexes. Employment: CES Survey, Bureau of Labor Statistics, U.S. Department of Labor, http://stats.bls.gov. 2) Metropolitan area data and building permits are not seasonally adjusted (nsa); all other series are Building permits: U.S. Census Bureau, http://www.census.gov. seasonally adjusted. Consumer price index: Bureau of Labor Statistics, http://stats.bls.gov. For more information, contact Robert Lacy at 804-697-8703 or e-mail [email protected].

Summer 2005 • Region Focus 49 STATE ECONOMIC CONDITIONS BY ANDREA HOLLAND

District of Columbia first quarter alone, prices shot up by 11.3 percent, bringing the four-quarter growth rate to 22.2 percent. As such, the conomic conditions in the District of Columbia District of Columbia ranked fourth nationwide in terms of Econtinued to gain momentum in early 2005. The first price gains. quarter saw a pickup in payrolls as well as a decline in the jobless rate and number of initial unemployment insurance claims. On the business front, venture capital investment U Maryland followed the national trend and waned somewhat, but the aryland’s economy grew on pace in the first quarter. residential and commercial real estate markets forged ahead. MThe latest economic reports showed a rebound in job numbers and continued strength in the residential real estate market. Private investment into state businesses, DC Home Sales, Q1:00-Q1:05 however, expanded at a slower clip. 50 According to the Bureau of Labor Statistics, business hir- US ing in Maryland continued to accelerate in the first quarter. DC Payrolls in the state expanded by 1.8 percent — or 11,067 jobs 25 — accounting for nearly half of the Fifth District’s total job growth. By sector, the bulk of the job creation came from the services side of the economy, with only the information sector 0 reporting losses. In contrast, payrolls were trimmed across

Annual Percent Change Annual Percent the board at goods-related establishments in the first quarter. Tracking the pickup in hiring, initial unemployment -25 00 01 02 03 04 05 insurance claims filed by Maryland residents fell 0.6 percent NOTE: Shaded Area Represents Recessionary Period in early 2005 — encouraging, but less than the 5.4 percent SOURCE: Sales of Existing Housing Units, National Association of Realtors® decline recorded nationwide. Also little changed was unem- ployment. Maryland’s jobless rate came in at 4.2 percent in District of Columbia payrolls expanded 1.1 percent in the the first quarter, matching the measures of both the prior first quarter of 2005. Strong gains in the leisure and hospital- quarter and a year earlier. ity sector — boosted in part by National Cherry Blossom Compared to the state, employment activity in the Festival-related tourism — offset modest job losses in other Baltimore metropolitan statistical area was less bright. industry sectors. According to the Richmond Fed’s most Metro area firms trimmed jobs by 7.6 percent in the first recent Beige Book, more than 1 million tourists attended the quarter, and the jobless rate inched 0.3 percentage point 93rd annual Cherry Blossom parade, a record for the event. higher to 4.9 percent. Indicators of household labor market conditions, such as Venture capital activity declined in the first quarter — initial unemployment insurance claims and the jobless rate, inflows were barely one-fifth of the level recorded in late also showed improvement in the first quarter. Initial claims 2004. Attracting more venture funds is a high priority in the dropped 4.4 percent, a steeper decline than in most other state, with legislators recently pushing for the establishment Fifth District jurisdictions. The jobless rate also posted a of an Entrepreneurial Investment Technology Tax Credit, significant drop — 0.7 percentage point — though much of the downward adjustment stemmed from the annual bench- mark revision. MD Home Sales, Q1:00-Q1:05 Venture capital investment was flat — the most recent 50 data showed no venture investment activity in the District of US Columbia between January and March of this year. The MD District of Columbia was not alone, though — 15 states 25 nationwide also reported flat activity in the first quarter. In real estate, the District of Columbia’s residential market continued to gain ground in the first quarter. New building 0

permit authorizations advanced strongly over the year as did Change Annual Percent sales of existing homes, which outpaced last year’s level by 0.7 -25 percent. Compared to other Fifth District jurisdictions, how- 00 01 02 03 04 05 ever, home sales in the District of Columbia advanced more NOTE: Shaded Area Represents Recessionary Period slowly, possibly due in part to escalating home prices. In the SOURCE: Sales of Existing Housing Units, National Association of Realtors®

50 Region Focus • Summer 2005 which early-stage investors could then apply toward their NC Home Sales, Q1:00-Q1:05 state income or insurance premium tax bill. Maryland’s residential real estate market advanced at a 50 moderate pace in early 2005. New permit growth was US robust, but sales of existing housing units backed off 10.1 NC percent in the first quarter. Even so, demand for housing 25 remained strong enough to boost prices by 15.9 percent in the first quarter, the largest quarterly jump recorded districtwide. 0 Annual Percent Change Annual Percent h -25 North Carolina 00 01 02 03 04 05 conomic conditions in North Carolina blew hot and cold NOTE: Shaded Area Represents Recessionary Period Ein the first quarter. Sluggishness persisted in state labor SOURCE: Sales of Existing Housing Units, National Association of Realtors® markets into early 2005, though indicators of business invest- ment and real estate conditions continued to firm. North Carolina exceeded the number authorized a quarter First-quarter employment activity was generally flat in earlier by 39.8 percent. North Carolina, with job losses outnumbering gains by only Existing home sales also forged ahead, expanding 21.8 per- 200. Manufacturing and natural resources and mining estab- cent in the first quarter — the strongest increase districtwide. lishments trimmed payrolls, as they had the previous quarter. Continued demand has boosted the price of the state’s housing Services companies also cut payrolls, with losses recorded in stock, but at a more tempered pace than seen in other areas. most industry sectors. Home prices rose by 7.4 percent in the first quarter, far less Reflecting lackluster payroll activity, North Carolina’s job- than the districtwide rate increase of 11 percent. less rate was little changed in the first quarter. The share of unemployed persons inched down 0.1 percentage point to 5.2 percent. Other measures of the labor market were less encour- o South Carolina aging. Initial unemployment insurance claims, which are often he economic upturn has advanced more slowly in South viewed as a signal of future labor market activity, rose 7.1 per- TCarolina than in other District states, with improvement cent in the first quarter — designating in the state’s labor markets slow to North Carolina as the only District take hold. The latest data suggest that state to record an increase in this meas- Economic conditions employment and venture capital ure. News from the job front was investment remain below their histor- similar in some of North Carolina’s in North Carolina ical highs, though South Carolina’s largest metro areas, with first-quarter blew hot and cold residential real estate market — payrolls in Charlotte and Raleigh con- buoyed by relatively moderate price tracting 4 percent and 3.8 percent, in the first quarter. increases — remained robust. respectively. South Carolina payrolls declined North Carolina has launched a an additional 0.2 percent in the first number of programs in recent years to attract more high- quarter, marking the third straight quarter of job losses. By salary jobs, one of the more recent of which is the proposed sector, jobs were trimmed at all establishment types except Defense Technology Innovation Center near Fort Bragg. The trade, transportation, and utilities, leisure and hospitality, business incubator would assist North Carolina companies information, and construction. The weak job market was also targeting government defense contracts. reflected in South Carolina’s unemployment rate, which edged The latest indicators of business activity in North Carolina up slightly to 7 percent in the first quarter. were more encouraging, with venture capital investment com- Employment data from South Carolina’s major metro areas ing in just shy of $100 million in the first quarter. Although the told a similar story. Payrolls edged lower in Charleston and first-quarter reading fell slightly short of late 2004 measures, Columbia in the first quarter, falling 2.8 percent and 3.6 per- North Carolina attracted the bulk of funding districtwide — cent, respectively. The jobless rate also kicked up sharply in accounting for more than 40 percent of total inflows. both areas – jumping from 4.6 percent to 6 percent in Looking next at the residential real estate market, the Charleston and 5 percent to 6.6 percent in Columbia. most recent data suggest that the sector continued to firm. News was also lackluster on the state’s business front. The number of first-quarter building permits issued in Venture capital funding was generally flat in the first quarter,

Summer 2005 • Region Focus 51 SC Home Sales, Q1:00-Q1:05 to 3.3 percent — the lowest unemployment rate districtwide. The state’s labor market is affected by military presence, 50 ranking second only to California in defense employment and US spending in 2003. As such, upcoming decisions from the SC Base Realignment and Closure Commission are of particular 25 import — especially around the Norfolk metro area, which is home to nearly half of Virginia’s military bases. In the first quarter, employment news from the Norfolk MSA wasn’t as 0 bright as reported statewide. Payrolls were trimmed 7.4 per-

Annual Percent Change Annual Percent cent from late 2004, though they remained 1.7 percent higher -25 over the year. 00 01 02 03 04 05 In state business conditions, recent reports were mostly NOTE: Shaded Area Represents Recessionary Period favorable. According to first-quarter data, Virginia saw an SOURCE: Sales of Existing Housing Units, National Association of Realtors® increase in venture capital inflows — bucking a districtwide and national downturn. The first-quarter expansion in fund- totaling a modest $200,000, a signifi- ing marked the second straight cant decrease from the $13.3 million quarterly gain for the state, following attracted a quarter earlier. Enhancing Residential real estate three periods of decline. the skills of South Carolina’s work- Virginia’s residential real estate force would make the state more activity in Virginia market powered forward in early attractive to outside investors. remained steady, despite 2005. Compared to year-ago levels, Moving in this direction, Claflin new building permit authorizations University in Orangeburg was one of rising home prices. rolled in at a slightly slower pace but 12 colleges nationwide selected to first-quarter existing home sales were receive $750,000 in federal funding earmarked to prepare students for biotechnology jobs. Further, the U.S. Labor Department reported that surrounding high VA Home Sales, Q1:00-Q1:05 schools would eventually have biotech lessons incorporated 50 into their curriculum as part of a long-term training program. US For now, though, the best news continued to come from VA South Carolina’s residential real estate market. First-quarter 25 permit authorizations expanded briskly compared to early 2004, with South Carolina posting the second strongest pick- up districtwide. Likewise, existing home sales came in above 0

year-ago levels, although they moderated somewhat from the Change Annual Percent fourth-quarter level. The slight abatement in sales, however, -25 was less pronounced than in most other District jurisdictions. 00 01 02 03 04 05 Home prices in South Carolina moved up only 7 percent in the NOTE: Shaded Area Represents Recessionary Period first quarter — the second slowest growth districtwide. SOURCE: Sales of Existing Housing Units, National Association of Realtors® u up 9.4 percent. Viewed against data from the fourth quarter of Virginia 2004, however, the pace of residential sales moderated — due he most recent measures of Virginia’s economy were partly perhaps to the sharp acceleration in Virginia home T generally upbeat. Employment and investment activity prices. In the first quarter alone, prices shot up by 15.2 percent, continued to firm, while residential real estate activity bringing the four-quarter growth rate to 18.6 percent — the 8th remained steady, despite rising home prices. strongest increase nationwide. Virginia firms boosted payrolls by 1 percent the first three months of 2005, and unemployment insurance claims w West Virginia retreated 0.6 percent. Jobs were added in all sectors except natural resources and mining, manufacturing, leisure and irst-quarter economic data suggest that West Virginia’s hospitality, and government. The jobless rate reflected the Feconomy continued to improve in early 2005. Although pickup in hiring at businesses, dropping 0.3 percentage point indicators of financial conditions at state businesses

52 Region Focus • Summer 2005 remained mixed, real estate and jobs activity were mostly WV Home Sales, Q1:00-Q1:05 positive across the board. Payroll employment rose 1.5 percent in West Virginia 50 during the first quarter of 2005, marking six quarters of US positive job growth. Gains were reported in the majority WV of industry sectors — even manufacturers tacked on a few 25 more jobs in early 2005 — but weakness persisted in natu- ral resources and mining, information, financial activities, and education and health services. By comparison, news 0 from the job front was not as bright in the Charleston Change Annual Percent metro area – first-quarter payrolls contracted 4.7 percent, -25 and the jobless rate shot up 1.5 percentage points to 5.9 00 01 02 03 04 05 percent. NOTE: Shaded Area Represents Recessionary Period The pickup in hiring was not fully reflected in other SOURCE: Sales of Existing Housing Units, National Association of Realtors® first-quarter labor market indicators. West Virginia’s job- less rate was unchanged in early 2005, holding fast at 5 recorded in other District states. For instance, first-quarter percent. Further, initial unemployment insurance claims home prices kicked up only 4.3 percent in West Virginia, only retreated 0.1 percent in the first quarter, far less than marking the slowest acceleration districtwide. West the 5.4 percent decline seen nationally. Looking back over Virginians have taken advantage of the relative affordability the year, however, improvement in these measures was of the state’s housing stock, as reflected by the sustained vol- more apparent — claims moved 12.8 percent lower and the ume in residential sales and building permits. Compared to a jobless rate declined by 0.4 percentage point. year ago, existing home sales in West Virginia stood 14.9 per- Recent employment and income gains have broadened cent higher in the first quarter, and permit authorizations home affordability in the state. According to recently were up 6.5 percent. released data by the Census Bureau, West Virginia had the Other recent indicators of business activity in West lowest median home price nationwide in 2003 ($78,201) just Virginia were less encouraging. First-quarter venture over half the national median price. Home prices in the capital inflows were flat — following a surge of $5.3 million state have risen steadily since then, but at a slower pace than in late 2004. Behind the Numbers: Housing Bubble? Economists disagree about both the definition of and the existence of a U.S. housing bubble. Deutsche Bank strategist Top-Five Fifth District Markets in Peter Garber says it’s nearly impossible to identify a true Home Price Appreciation Through Q1:05 bubble, while Yale economist Robert Shiller, author of Metro Area Rank* One-Year Five-Year Irrational Exuberance, offers this description: “a situation in which temporarily high prices are sustained largely by Washington, DC 27 23.14 93.65 investors’ enthusiasm rather than by consistent estimation Baltimore, MD 45 20.96 76.04 of real value.” Hagerstown, MD 58 20.19 68.20 But how to gauge if prices are temporarily high? Among Va. Beach-Norfolk, VA 59 22.12 67.56 the traditional measures are the housing price index (HPI) Charlottesville, VA 63 17.23 64.51 and the price-to-rent ratio. In a recent study, the Federal Others Deposit Insurance Corporation (FDIC) looked at the HPI Yuba City, CA 1 26.03 121.96 and said the number of “boom” markets grew by 72 percent Los Angeles, CA 16 25.55 105.52 last year, now encompassing 55 metropolitan areas, including New York, NY 44 15.57 76.55 five in the Fifth District. Nationally, the price-to-rent ratio San Francisco, CA 66 17.50 62.88 grew by nearly 30 percent in the past five years. The FDIC Chicago, IL 95 10.57 45.10 notes that a housing boom seldom leads to a housing bust — Atlanta, GA 145 4.86 29.07 which ought to give some reassurance to homeowners in the *Ranked by five-year change among 265 metro areas Washington, D.C., metro area, whose housing prices nearly SOURCE: Office of Federal Housing Enterprise Oversight doubled over the past five years. —DOUG CAMPBELL

Summer 2005 • Region Focus 53 State Data, Q1:05

DC MD NC SC VA WV Nonfarm Employment (000) 674.9 2,546.3 3,850.0 1,820.0 3,629.8 740.7 Q/Q Percent Change 1.1 1.8 0.0 -0.2 1.0 1.5 Y/Y Percent Change 0.6 1.6 1.3 0.1 2.4 1.0

Manufacturing Employment (000) 2.4 140.4 575.6 265.2 298.4 62.7 Q/Q Percent Change -10.4 -5.1 -2.8 -5.1 -2.0 0.2 Y/Y Percent Change -2.7 -1.9 -0.3 -0.8 0.0 -1.1

Professional/Business Services Employment (000) 143.1 380.7 434.7 183.2 591.5 58.0 Q/Q Percent Change 0.1 3.7 -1.8 -14.7 2.0 0.5 Y/Y Percent Change 0.8 3.0 2.6 -2.6 4.9 -0.7

Government Employment (000) 230.7 462.0 650.7 329.7 654.4 143.1 Q/Q Percent Change -0.6 0.7 0.5 -1.8 -0.4 0.7 Y/Y Percent Change 0.0 -0.8 0.7 1.8 1.3 0.3

Civilian Labor Force (000) 305.1 2,896.4 4,283.7 2,073.0 3,855.3 792.2 Q/Q Percent Change 5.1 1.5 1.9 2.5 2.5 3.3 Y/Y Percent Change 2.1 0.6 0.9 2.0 1.6 0.3

Unemployment Rate (%) 8.0 4.2 5.2 7.0 3.3 5.0 Q4:04 8.7 4.2 5.3 6.9 3.6 5.0 Q1:04 7.6 4.2 5.8 6.7 3.7 5.4

Personal Income ($bil) 27.4 209.7 239.7 108.5 255.3 44.9 Q/Q Percent Change 0.8 0.7 0.6 0.2 0.7 1.1 Y/Y Percent Change 4.1 4.6 4.9 4.0 5.5 4.6

Building Permits 565 7,745 22,161 12,650 13,460 1,336 Q/Q Percent Change 602.9 33.1 39.8 97.0 -6.0 132.4 Y/Y Percent Change 269.3 31.8 -0.8 33.5 -9.9 6.5

House Price Index (1980=100) 511.5 421.2 294.2 275.8 385.2 216.8 Q/Q Percent Change 11.3 15.9 7.4 7.0 15.2 4.3 Y/Y Percent Change 22.2 21.0 6.0 6.9 18.6 7.8

Sales of Existing Housing Units (000) 14.4 130.2 213.5 102.5 183.5 34.7 Q/Q Percent Change -10.0 -10.1 21.8 -1.6 -6.3 -29.8 Y/Y Percent Change 0.7 -1.1 12.7 12.3 9.4 14.9

NOTES: Nonfarm Employment, thousands of jobs, seasonally adjusted (SA); Bureau of Labor Statistics (BLS)/Haver Analytics, Manufacturing, thousands of jobs, SA; BLS/Haver Analytics, Professional/Business Services, thousands of jobs, SA; BLS/Haver Analytics Government, thousands of jobs, SA; BLS/Haver Analytics, Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics, Unemployment Rate, percent, SA; BLS/Haver Analytics, Personal Income, billions of chained 2000$, Bureau of Economic Analysis/Haver Analytics, Building Permits, number of permits, NSA; U.S. Census Bureau/Haver Analytics, House Price Index, 1980=100, NSA, Office of Federal Housing Enterprise Oversight/Haver Analytics, Sales of Existing Housing Units, thousands of units, SA; National Association of Realtors®

54 Region Focus • Summer 2005 Metropolitan Area Data, Q1:05

Washington, DC MSA Baltimore, MD MSA Charlotte, NC MSA Nonfarm Employment (000) 2,869.4 1,249.4 783.2 Q/Q Percent Change -2.9 -7.6 -4.0 Y/Y Percent Change 2.8 0.7 3.2

Unemployment Rate (%) 3.7 4.9 5.4 Q4:04 3.2 4.6 5.6 Q1:04 3.4 5.0 6.5

Building Permits 8,304 2,100 4,734 Q/Q Percent Change 24.2 -71.9 8.2 Y/Y Percent Change 0.5 8.2 -5.1

Raleigh, NC MSA Charleston, SC MSA Columbia, SC MSA Nonfarm Employment (000) 266.1 274.1 343.5 Q/Q Percent Change -3.8 -2.8 -3.6 Y/Y Percent Change 1.3 3.2 1.5

Unemployment Rate (%) 4.1 6.0 6.6 Q4:04 3.5 4.6 5.0 Q1:04 4.0 4.5 4.8

Building Permits 3,139 2,522 1,810 Q/Q Percent Change 5.3 125.1 45.2 Y/Y Percent Change -16.9 51.8 10.0

Norfolk, VA MSA Richmond, VA MSA Charleston, WV MSA Nonfarm Employment (000) 744.0 606.6 147.2 Q/Q Percent Change -7.4 -2.1 -4.7 Y/Y Percent Change 1.7 2.2 0.6

Unemployment Rate (%) 4.1 3.8 5.9 Q4:04 4.4 4.0 4.4 Q2:04 4.6 4.3 5.2

Building Permits 2,427 2,820 68 Q/Q Percent Change -26.5 209.0 0.0 Y/Y Percent Change -1.5 30.0 -18.1

For more information, contact Andrea Holland at 804-697-8273 or e-mail [email protected].

Summer 2005 • Region Focus 55 OPINION The Economics of Bankruptcy BY KARTIK ATHREYA

ew people seriously challenge the idea that there defaulting under any circumstances (an admittedly extreme should be some form of personal bankruptcy protec- and unrealistic scenario) it would become significantly cheaper Ftion. In most circles it’s taken for granted that the to borrow. In the models I’ve looked at, the gains accruing per availability of an option allowing people to erase their debts U.S. household would be equivalent to as much as $280 a year. is a proper response to the hazards of modern-day financial These gains encompass everything from cheaper borrowing life. The elderly get sick and can’t pay their medical bills. costs to eliminating after-the-fact punishments like stigma. Young mothers get divorced and are awarded sole custody of Another way to see this is to consider the difference their children — and then they lose their jobs. Bankruptcy is between borrowing on a home equity line versus a credit the ultimate safety net. card. The roughly 10 percent wedge in interest rates between Reforms signed into law this spring by President Bush home equity lines, which are backed by the collateral of prop- make it harder for individuals to walk away from their debts. erty, and credit cards, which are unsecured, is a striking But the new rules don’t address this basic question: From an indicator of the value of a credible commitment to repay economic perspective, is bankruptcy protection — even after debts. On a loan of $10,000, this “credibility gap” may cost the latest overhaul — really sensible? unsecured borrowers $1,000 more annually than their collat- The answer is not perfectly straightforward. But recent eralized counterparts. research, including some of my own, leads me to be skeptical Given the large costs bankruptcy law imposes on house- about what economists call the “welfare-improving” virtues holds, especially poor ones, there is too much at stake to of bankruptcy, particularly for non-entrepreneurs. By that allow policy to be guided by the current, somewhat hysteri- I mean the wider costs of maintaining the personal cal debate. What I want is a policy debate that relies less on bankruptcy system appear to outstrip the benefits. emotionally charged stories about tragically unlucky filers or At its heart, personal bankruptcy wealthy abusers of the system. We is an insurance program. It aims to must focus more on a careful and provide a backstop against financial From an economic perspective, hard-headed accounting of bank- misfortune for which there exist few ruptcy’s actual costs and benefits. private-sector alternatives. Drivers is bankruptcy protection — Roughly 1 million U.S. households can be insured against accidents filed for Chapter 7 bankruptcy pro- because it’s relatively easy for insur- even after the latest overhaul — tection last year. Tougher bankruptcy ers to assess the level of risk each eligibility rules than those that have driver represents. But it’s not as easy really sensible? been presented so far would improve to size up a person’s financial risk. the terms and availability of credit How hard an unemployed person is for all Americans. In particular, such looking for new work, for example, is tricky for an outsider rules would benefit the 60 million people between the ages to gauge. So instead of private insurance, we have opted of 20 and 35 who today face the highest costs in obtaining for a de facto government-mandated insurance program in unsecured credit. bankruptcy protection. In a world of competing and evolving insurance programs, The problem with this system is that it raises costs for does personal bankruptcy still serve us well? Among econo- everybody. In particular, it raises the cost of unsecured credit mists addressing these questions, there is an emerging — chiefly, credit cards and bills for medical care — for the consensus against bankruptcy as it’s currently practiced. But people who most need it, young people and poor people, this conclusion leaves the door open for some extreme cases both of whom usually lack collateral. — sudden medical setbacks in particular. More generally, The law says that people have a right to avoid unsecured we should think harder about other ways to help people debts by seeking bankruptcy protection. Creditors know that facing catastrophic health events. everybody they lend to has this option. It’s expensive to bor- That may be just another way of saying that I believe row in this kind of world because lenders must charge extra we should offer some form of bankruptcy, albeit with for the very real possibility that they won’t be able to fully col- strings attached. Means-testing, while piecemeal, seems like lect. In effect, bankruptcy law disables those who possess few a small step in the right direction. The more fundamental assets from making commitments to fully repay debts. task of understanding bankruptcy’s redistributive- and Why do we foist this “protection” on all households? incentive-related implications remains squarely in front of If we lived in a society that allowed borrowing but forbade both lawmakers and researchers. RF

56 Region Focus • Summer 2005 NEXTISSUE

Smart Start Economic History Early childhood education programs have become a top The Civil War was hugely expensive — both priority for many policymakers, including some who believe in human and dollar terms. The Union and they are a promising economic development strategy. Such the Confederacy employed significantly programs, officials say, help kids acquire skills that they can different methods to finance the war. We’ll build upon throughout their lives, resulting ultimately in a examine the monetary policies of the well-trained workforce. We’ll take a look at North Carolina’s North and the South, and consider how the “Smart Start” initiative and see how this program has fared Civil War ushered in lasting changes to the since its inception in 1993. nation’s financial system.

Are Entrepreneurs Born or Made? Interview A conversation with Robert Moffitt, a labor Entrepreneurial activity is key to our nation’s dynamic economy. economist at Johns Hopkins University and But can it be taught? Some think so. For instance, students at editor of the American Economic Review. Western Carolina University’s School of Business can major in entrepreneurship. We’ll speak with analysts who have studied the topic, as well as with entrepreneurs themselves. Research Spotlight What can we learn about economics by looking at people’s brain activity? A survey Why Do Economists and the Public So of the growing “neuroeconomics” literature. Frequently Disagree? Most economists favor free trade, but many people think that globalization is harmful. Similarly, economists generally advocate incentive-based approaches to regulation, while the public often supports direct controls. How large is the gap between the way economists and the general public think about policy issues? And why do the differences exist?

Eminent Domain The Supreme Court recently issued a decision that makes it easier for government to seize private property for public use. Visit us online: What is the economic justification for “eminent domain” measures, and do recent public-directed development projects www.richmondfed.org satisfy that threshold? • To view each issue’s articles and web-exclusive content

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The Fall 2005 issue will be published in October. The Economic Forces Behind Wage Inequality

he gap in real wage rates between In the Federal Reserve Bank of Richmond’s 2004 Annual Report Tthose at the higher end of the feature article, “What’s Driving Wage Inequality? The Effects of income distribution and those at the Technical Change on the Labor Market,” the Bank’s Director of lower end has been widening for Research and the editor of Region Focus argue that advancements about 30 years. Some have attributed in technology, particularly information technology, have boosted the productivity of skilled labor relative to that of unskilled labor. this growth in wage inequality to Such “skill-biased technical change” has led to greater wage globalization. But there is another dispersion, they contend. The authors maintain that efforts to slow important force affecting America’s international trade likely would have little effect on wage patterns, labor markets — technical innovation. while reducing overall welfare, and suggest that a more promising policy response would be to increase emphasis on early childhood education and broadly applicable skills.

The Annual Report also includes messages from the president and management, in which they discuss the economy and Bank operations, and an overview of the Richmond Fed’s 2004 financial activity.

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