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WINTER 2005

THE FEDERAL RESERVE BANK OF RICHMOND BANKS BRANCHING OUT . . . It’s All About Location, Location, Location

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VOLUME 9 COVER STORY NUMBER 1 12 WINTER 2005

Branch Bonanza: They cost a lot, but customers can’t get Our mission is to provide enough of them. Why bank branches won’t go away authoritative information Bank branches are expensive to build, maintain, and staff. So how and analysis about the come the number of bank branches keeps right on growing? It turns Fifth Federal Reserve District out that customers aren’t ready for virtual banking just yet – and economy and the Federal banks that are following their customers’ lead are being rewarded Reserve System. The Fifth with both deposits and profits. District consists of the District of Columbia, FEATURES Maryland, North Carolina, 18 South Carolina, Virginia, The Conference Shuffle: The Atlantic Coast Conference set and most of West Virginia. off a wave of league swaps The material appearing in In 2003 the ACC plucked three schools from the Big East. Within Region Focus is collected and developed by the Research months, another 16 schools switched conferences. It all makes sense Department of the Federal from an economic perspective. Reserve Bank of Richmond. 23 DIRECTOR OF PUBLICATIONS Sink or Swim: Fifth District coastal ports must continue to John A. Weinberg expand to remain competitive EDITOR Port authorities in Baltimore, Md.; Charleston, S.C.; Hampton Roads, Aaron Steelman Va.; and Wilmington, N.C., have invested heavily in infrastructure SENIOR EDITOR Doug Campbell improvements and expansions. These investments have been essential to respond to bigger ships, higher volumes of cargo, and greater use MANAGING EDITOR Kathy Constant of containers. BUSINESS WRITERS 28 Charles Gerena Betty Joyce Nash

Shame and Bankruptcy: The number of Americans filing for EDITORIAL ASSOCIATE bankruptcy protection has surged fivefold in two decades Julia R. Taylor A Richmond Fed economist challenges the conventional wisdom CONTRIBUTORS that increasing bankruptcy rates are attributable to falling stigma, but Joan Coogan the debate is far from over. Eric Nielsen Christian Pascasio 32 Jennifer Wang ECONOMICS ADVISERS Hard Times: North Carolina’s northeast counties are among Andrea Holland the poorest in the nation. Can they reverse course? Robert Lacy This region of North Carolina is too far inland to gain from the coastal Ray Owens construction boom and too isolated from big cities to benefit from CIRCULATION their diverse job mix. Instead, it’s piecing together an economy of its Walter Love Shannell McCall own, using natural assets along with state money to bring in jobs. DESIGN 36 Ailsa Long Happy Trails: Horses are used more for pleasure than Published quarterly by the Federal Reserve Bank business but still have a place in Fifth District agriculture of Richmond The horse industry encompasses a variety of recreational activities P. O. Box 27622 and generates millions of dollars throughout the Fifth District. The Richmond, VA23261 E-mail: animals that once served farmers as beasts of burden are now sources [email protected] of companionship and enjoyment. www.rich.frb.org/pubs/regionfocus Subscriptions and additional DEPARTMENTS copies: Available free of charge by calling the Public Affairs Division at (804) 697-8109. 1 Noteworthy/Does Deregulation Undermine Stability? Reprints: Text may be reprinted 2Federal Reserve/Inflation Targeting with the disclaimer in italics below. Permission from the 5 Legislative Update/Manufacturing and Tobacco editor is required before 6 Jargon Alert/Sunk Cost reprinting photos, charts, and tables. Credit Region Focus and 7Research Spotlight/ Is Good Journalism Good Business? send the editor a copy of the publication in which the 8 Short Takes reprinted material appears. 39 Economic History/The Border Line and the Bottom Line The views expressed in Region Focus are those of the contributors and not 42 Interview/Frank Sloan necessarily those of the Federal Reserve Bank of Richmond or the Federal 46 Book Review/The New Division of Labor: Reserve System. COVER: How Computers Are Creating the Next Job Market Skyline of Charlotte, N.C., ISSN 1093-1767 one of America’s banking hubs 48 Regional/District Economic Developments PHOTOGRAPHY: ANNE RIPPY/GETTYIMAGES 56 Opinion/The Broken Window Fallacy RF Winter 04 FINAL.ps - 1/10/2005 13:56 PM

NOTEWORTHY Does Deregulation Undermine Stability?

ne of the Federal Reserve’s Deposit insurance programs presented a moral hazard most important duties is problem: Some banks got too big too fast, secure in the Oto make sure that the na- knowledge that there was a safety net to protect them from tion’s financial system is stable. bad business decisions. The problem was particularly acute in But how should we and other heavily agricultural states, where banks loaned freely during bank regulators go about achiev- the agricultural boom of 1914 to 1920, but faced hard times ing this goal? That’s a large and when farm goods prices began to fall. In fact, all the state complicated question. deposit insurance fund systems collapsed during the 1920s. In many ways, the banking Meanwhile, branch banking proved quite successful. As industry in the United States was Columbia University economist Charles Calomiris has writ- shaped by the events of the 1930s. ten, “States that allowed branch banking saw much lower The collapse of a number of failure rates — reflecting the unusually high survivability of financial institutions led to regulations that limited the activi- branching banks — and responded well to the agricultural ties of banks. This was meant to shelter them from risk and to crisis by consolidating banks and expanding branching sys- prevent additional collapses. At the same time, efforts were tems, where this was allowed.” made to protect the consumer from another wave of bank fail- Consider an example from the Fifth District: South ures. In particular, the federal government began insuring Carolina. Its economy, like those of other primarily agricul- deposits through the Federal Deposit Insurance Corporation. tural states, was hurt by the drop in farm prices during the A quick glance at the post-Depression history of the 1920s. But its banking system stood up relatively well — as banking industry would seem to vindicate these decisions. did the banking systems in most other states that Until recently, many of the regulations that went on the permitted branch banking. books in the 1930s were still in operation — and overall, the The success of branch banking may seem counterintu- industry has been quite stable, with relatively few failures. itive. It might appear that a bank with branches spread But does this necessarily mean that such regulations were throughout a region is especially risky since that bank often the best — or only — course of action? I don’t think so. has more to lose than a bank with just one office. But the In fact, research suggests that the collapse of the 1930s very fact that a bank has a large and diversified portfolio could have been averted — or at least would have been actually enhances its stability. Its risk is spread over a wider considerably less severe — had the regulation of the banking pool, meaning that if business is ailing in one area, others industry been less restrictive prior to the Depression. As the may remain healthy. cover story in this issue of Region Focus discusses, branch In contrast, the more geographically concentrated a banking has grown dramatically in the United States in bank’s depositor base and lending clientele, the more risk it the past decade. Freed from regulations that confined their faces. In such a world, if one segment of its customers is business activities to specific states or geographic regions, facing problems, it’s likely that other parts are as well. This some banks are now operating on a nearly national scale, can put a bank under severe, and perhaps fatal, pressure — and with branches throughout the country. is arguably what happened to many banks during the 1930s. At first blush, such expansion might seem like a poten- So, overall, I think that we should look at the deregula- tially risky phenomenon. After all, the bigger an institution tion of the banking industry and the resulting rise of inter- gets, the more it has to lose, right? At one level this is correct: state branch banking as a welcome occurrence. The U.S. The collapse of a large bank with branches in numerous financial system, I believe, will become more efficient over areas would pose a significant problem to the nation’s finan- time. And for the reasons I have discussed, I think it also will cial system. become more stable. Both are healthy trends for consumers. But the data pose an interesting problem for proponents of regulation. Prior to the Depression, some states pro- hibited branch banking while others allowed it. In addition, some states already had deposit insurance programs of their own. How did the different states fare? On balance, banks in states that permitted branch banking and did not adopt JEFFREY M. LACKER deposit insurance programs performed better than banks in PRESIDENT states with tighter regulatory environments. FEDERAL RESERVE BANK OF RICHMOND

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FEDERALRESERVE Inflation Targeting BY JENNIFER WANG

The debate over n January of 1995, the Federal Open to institutionalize monetary policy. Market Committee (FOMC) held They believe implementing a formal best-practice Ia debate on inflation targeting. Al inflation target will cement the hard- Broaddus, then-president of the won gains of price stability throughout monetary policy Richmond Fed, presented arguments leadership transitions. On the other in favor of inflation targeting, while hand, opponents of inflation targeting is escalating: Governor Janet Yellen (now president deem it unwise to tamper with a discre- of the Federal Reserve Bank of San tionary policy that has thus far proven Will it be Francisco) provided the counterargu- so successful. rule-based or ments. The debate ended with Chairman So the question the Fed appears to be Alan Greenspan declaring the asking itself is: Which will better stand discretionary? Committee “as split down the middle the test of time — rules or discretion? as we could possibly get.” A decade later, the issue of infla- The What, How, and Why of tion targeting continues to spark dis- Inflation Targeting cussion within the Federal Reserve What does the term “inflation target- System. The topic remains as contro- ing” mean? Marvin Goodfriend, senior versial as ever, and as Greenspan’s cur- vice president and policy advisor at the rent and final term draws nearer to its Richmond Fed, defines inflation target- February 2006 end date, the topic will ing as “a framework for monetary policy no doubt receive additional attention. characterized by the announcement of Since 1979, the Fed has vigorously an official target for the inflation rate pursued a policy of price stability, first and by an acknowledgement that low under Chairman Paul Volcker, and now inflation is a priority for monetary under Chairman Greenspan. But policy.” uncertainty over Greenspan’s successor To implement an inflation targeting causes some to fear that discretionary framework, the Fed must first declare a power in the wrong hands may reverse specific numerical target (or range) for the work done in the last 25 years. inflation, which is measured by a price The proposed solution? An inflation index such as the CPI or the PCE. The targeting framework for monetary policy. Fed would then pledge to achieve and While inflation levels are stable, maintain inflation within these bounds advocates of an inflation targeting over a stated time horizon. framework want to set a few guidelines Theoretically, through improved Bank of England communication with the markets, and Governor Mervyn King repeated success in attaining target (left) talks with objectives, an inflation targeting U.S. Federal Reserve framework would lead to increased Chairman Alan transparency and credibility for the Greenspan (center) and central bank, fostering an environ- the President of the ment conducive to sustained price European Central Bank, Jean Claude Trichet stability and economic growth. (right), at the Looking briefly at monetary policy 2004 G20 conference in abroad over the past 15 years, it is not Berlin. The Bank of difficult to see why a proposal to put England has adopted an inflation targeting in practice is so inflation targeting compelling. In December of 1989, the framework, while the New Zealand Parliament codified Fed and the ECB inflation targeting as the country’s

remain undecided. WORLD AP/WIDE PHOTOGRAPHY:

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framework for conducting monetary was an early champion of inflation system of rules rather than upon the policy. Since then, 20 other countries targeting. Mishkin articulates the vagaries of individuals, and is less — including industrial, transitional, second advantage: Policymaking would prone to political manipulation or and even developing economies — become less dependent on a chairman’s pressure.” have adopted similar legislation with personal philosophy. “We have as strong some degree of success (see table). a nominal anchor as any country that … Or No? In the United States, during the has announced inflation targeting. On the other side of the fence, skeptics period known as the Volcker disinfla- The problem is that nominal anchor of inflation targeting, including many tion (1979 to ’87), the Fed brought is embodied in Chairman Greenspan.” economists within the Fed, believe down core inflation from 10 percent to Left alone, this strategy could prove there would be a number of disadvan- 4 percent. Subsequently, inflation has dangerous. tages associated with the adoption of remained low and relatively stable. “Putting in an inflation targeting an inflation targeting framework. Pursuing “hawkish” inflation policies regime is, in a sense, trying to provide a The first and most frequently dis- also led the Volcker-Greenspan Fed to succession plan for Greenspan,” cussed issue pertains to the advantage more elusive, unquantifiable accom- Mishkin suggests. “We’d like to clone of having policymaking flexibility with- plishments like the reestablishment of Greenspan. We can’t. But what we in a discretionary framework. Federal central bank credibility and a restored would like to do is imbibe a future pol- Reserve Board Governor Donald Kohn faith in the Fed’s commitment to low icy framework with the basic principles agrees the Fed has conducted policy inflation. [of price stability] in which he has with an eye on long-run price stability, Indeed, Goodfriend and others have operated.” but is not convinced that recent success argued that although the Fed has never Results from countries that practice is due to implicit inflation targeting. explicitly employed inflation target- inflation targeting have been generally Rather, it is derived in large part from ing, it has long done so implicitly. positive. Across the board, average the Fed’s “ability to adapt to changing Goodfriend, a strong supporter of infla- inflation has dropped significantly after conditions — a flexibility that likely tion targeting within the Federal an inflation-targeting policy was has benefited from the absence of an Reserve System, summarizes his case: adopted. In the United Kingdom, for inflation target.” “When one considers the Greenspan example, inflation fluctuated wildly Thomas Schlesinger, executive era as a whole, it would appear that the until the adoption of inflation targeting director of the Financial Markets Greenspan Fed adopted, gradually and in 1992. Since then, inflation has been Center and a vocal critic of inflation implicitly, an approach to monetary pol- brought down to manageable levels for targeting, says that the evidence from icy that can be characterized as infla- the first time in many decades. abroad is not as clear as supporters of tion targeting.” The question becomes: But inflation targeting is certainly inflation targeting might suggest. Should the Fed take the next step and no magic wand, and supporters stress Schlesinger cites a paper by Laurence declare an explicit inflation target? that it should be viewed as a frame- Ball and Niamh Sheridan that con- work or set of guidelines — not a rigid cludes that after factoring in regressions Yes … rule. Mervyn King of the Bank of to the mean, there is “no evidence that Supporters of inflation targeting say it England has been careful to point out inflation targeting improves perform- would generate two significant advan- that inflation targeting is “a way of ance as measured by the behavior of tages over the status quo. Mickey Levy, thinking about policy. It isn’t an auto- inflation, output or interest rates.” chief economist at Bank of America, matic answer to all the difficult policy Schlesinger identifies another reason identifies one of the main benefits: questions.” why an inflation targeting model might more clarity regarding policy decisions. Supporters of inflation targeting prove inadequate: “It ignores obvious “I think a lot of the difficulty or believe a policy change will be easiest and important questions about finan- confusion the Fed has had over its to implement while inflation is already cial stability problems that can occur announcements about monetary policy low, and the public and markets are in a low inflation regime,” he says. would evaporate if the Fed had a familiar with the approach. Even “The evidence indicates … that manag- properly stated monetary policy or Congress is thinking about it. ing the economy in periods of sus- inflation guideline,” Levy says. With Robert Keleher, chief macro- tained low inflation can be just as inflation targeting, “I think the issue of economist of the Joint Economic tricky, if not trickier, than achieving transparency becomes much more Committee of the U.S. Congress, has the goal of price stability. We’ve seen straightforward, which would help the argued that inflation targeting would that asset bubbles and busts can and Fed avoid some of the problems it’s have the effect of “institutionalizing have occurred in periods of sustained run into in the last few years.” and depersonalizing the goal of price low inflation.” Frederic Mishkin, a professor of stability.” This, he says, “will help Finally, skeptics of inflation target- banking and financial institutions at ensure that Federal Reserve perform- ing argue that adopting an inflation tar- Columbia University’s Business School, ance depends more on a transparent get is simply unnecessary. The United

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States has done well without inflation “useful for central banks in transition establishing a time period for an infla- targeting, they say, and it is hard to to price stability. But in the United tion target, and the need to define a justify a policy change when there is States, I don’t know why we would be coping strategy should the inflation little evidence to suggest the economy worse off one way or the other.” rate move toward the ends of a target would profit more under a different The ambiguity inherent in Gertler’s range. regime — particularly since cred- statement echoes the sentiments of Although Hoffman acknowledges ibility could erode if the Fed fails to economists in the banking and finan- that such a change will be difficult to achieve its target range. Moreover, cial services industries who think that implement, he remains hopeful. “I there are less drastic alternatives avail- it is still too early to tell. think the market would benefit from able to increase policy transparency, Stuart Hoffman, chief economist some explicit inflation target frame- such as earlier releases of records and at PNC Financial Services Group, work from the Fed,” he says. “It would forecasts. thinks an explicit inflation targeting be a learning process for the Fed. It framework won’t happen for a while. would be a learning process for the Rules vs. Discretion in a The most basic details have yet to be markets. But I think it would be a good Post-Greenspan Fed worked out — down to which inflation discipline, and I do think it might help Mark Gertler, chairman and professor measure to use, and what the appro- to anchor public and market inflation of the economics department at NYU, priate ranges would be for a target. expectations.” believes that inflation targeting is Hoffman also alludes to the trouble of When asked to speculate about the future look of a post-Greenspan Fed, Bank of America’s Mickey Levy replies Does Inflation Targeting Work? with optimism. “Anything can happen, Average inflation rates have fallen more rapidly in countries with inflation targeting (IT) but the Federal Reserve and the whole regimes, but they have also had more room for improvement. of the financial community recognize the economic benefits of stable low Sample IT Year IT 1980 to 1990 to 1998 to Countries Began 1989 1999 2001 inflation, and so even under a new Fed regime with a new chair, the impetus is Australia 1994 8.4 2.5 2.8 toward continuity, and the policy Canada 1991 6.5 2.2 2.0 thrust toward stable low inflation.” Chile 1991 21.2 11.5 4.0 Ultimately, the decision of imple- Israel 1992 104.7 11.2 3.2 menting inflation targeting can be South Korea 1998 8.1 5.7 3.6 thought of as a choice between stabili- New Zealand 1990 11.8 2.1 1.6 ty or flexibility, rules or discretion. Poland 1998 43.0 52.0 8.6 “You don’t want to adopt a policy or not adopt a policy because of cur- Sweden 1993 7.9 3.2 0.9 rent circumstances. You want to adopt United Kingdom 1992 7.4 3.7 2.4 a policy that works under all sorts of Sample Non-IT circumstances — not just in times of Countries economic depression or economic Japan - 2.5 1.2 -0.3 prosperity,” cautions Joel Naroff, chief United States - 5.5 3.0 2.5 economist for Commerce Bank. “My Euro area - 6.6 2.8 1.8 view is that either the policy is correct to be implemented under all sets of SOURCE: Bank for International Settlements circumstances, or it shouldn’t be implemented at all.” RF

R EADINGS Ball, Laurence, and Niamh Sheridan. “Does Inflation Targeting Keleher, Robert. “Lessons from Inflation Targeting Experience.” Matter?” National Bureau of Economic Research Working Paper AReport from the Joint Economic Committee of the U.S. no. 9577, March 2003. Congress, February 1997. Bernanke, Ben S., Thomas Laubach, Frederic S. Mishkin, and King, Mervyn. “The Inflation Target Five Years On.” Speech Adam S. Posen. Inflation Targeting: Lessons from the International delivered at the London School of Economics, October 29, 1997. Experience. Princeton: Princeton University Press, 2001. Kohn, Donald L. Remarks at the Federal Reserve Bank of Goodfriend, Marvin. “Inflation Targeting in the United States?” St. Louis’ 28th Annual Policy Conference, “Inflation Targeting: National Bureau of Economic Research Working Paper no. 9981, Prospects and Problems,” October 17, 2003. September 2003. Visit www.rich.frb.org/pubs/regionfocus for links to relevant sites and supplemental information.

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LEGISLATIVEUPDATE Big Changes for Regional Manufacturing and Tobacco Sectors BY CHARLES GERENA

resident Bush signed the American Jobs Creation Act on because the marginal incentive to do things is going to be high- the eve of his 2004 re-election. Among other things, the er when our rate is lower relative to our foreign counterparts.” P legislation contains accounting changes and tax breaks intended to benefit various sectors of the national economy, Bye-Bye, Price Supports from restaurant owners to producers of biodiesel fuel. It may In the Fifth District, the provision of the Jobs Creation Act even stave off a trade war by repealing a tax break on the that has garnered the most attention has been the “Fair and export income of manufacturers called an extraterritorial Equitable Tobacco Reform Act,” which eliminates federal income exclusion (ETI). The ETI had angered the European price supports and the quota system that controls tobacco Union enough to impose tariffs on U.S. exports last March. leaf production. To soften the blow, quota holders and The Jobs Creation Act will affect two bedrocks of the Fifth tobacco growers will receive annual payments over the next District regional economy: manufacturing and tobacco. 10 years, up to a maximum of $9.6 billion. The tobacco subsidy program began during the Great Hello, Tax Deduction Depression to help farmers cope with falling prices. Since While some manufacturers lose the then, it has succeeded in keeping ETI, many more will gain from the cor- domestic tobacco prices up and nucopia of provisions in the Jobs The Big Tobacco Payoff domestic production down, says North Carolina will get the biggest chunk of Creation Act. For one thing, they will economist Richard Ault at Auburn the federal tobacco buyout: 41 percent of receive more than $8 billion of tax University. That hasn’t been good for the $9.6 billion total payout over the next 10 breaks over the next three years to off- tobacco product manufacturers years. Maryland wasn’t included in the buyout, set the impact of the ETI repeal. because they want greater flexibility while West Virginia received very little money. In addition, manufacturers will be and more stability in their supply. able to deduct 9 percent of gross 4.0 Higher tobacco prices also “created income generated by “domestic produc- 3.5 an incentive and an opportunity for tion activities,” minus certain items. 3.0 Quota Owner imported tobacco to come into the Payments ILLIONS Grower

The deduction phases in over the next M 2.5 market,” Ault says. “In the last 20 years, Payments N five years. I Total Buyout other countries have developed tobacco 2.0 Payments The bill’s definition of “domestic that is a very good substitute for high- 1.5 YMENTS A

production activities” includes com- P quality American tobacco, particularly 1.0 modities that aren’t traditionally con- Brazil.” As U.S. tobacco production has sidered manufactured goods, including 0.5 fallen and quotas have been lowered, 0 construction projects, television North South Virginia quota holders have watched their shows, and electricity. While this Carolina Carolina assets diminish in value. Ault says that NOTE: Adding owner payments and grower payments broad description is meant to spread may not equal total buyout payments due to rounding. is why they have been anxious to be the benefits of the deduction widely, it SOURCE: Agricultural Policy Analysis Center, University bought out by Uncle Sam. of Tennessee also adds confusion to an already con- As for farmers, those who hold voluted tax code. quotas will immediately benefit from “You are going to create incentives to label activities the annual payments they will receive. Also, they will no within the firm as production that may or may not be longer have to buy or rent quotas to increase production. But production. That’s going to lead to a lot of paperwork some may see the value of their land drop because plots with for the IRS and the accountants,” says Kimberly Clausing, tobacco quotas associated with them commanded a premium an economist and tax policy expert at Reed College that no longer exists. Eliminating tobacco subsidies will also who has closely studied the provisions of the Jobs Creation remove a major justification for the warehouse-based auction Act. Indeed, PricewaterhouseCoopers expressed its con- system, which offers farmers an alternative to direct con- cerns about the uncertainties surrounding the deduction tracts with manufacturers. Only tobacco sold at auction is in a recent report to its clients. eligible for price supports, not tobacco sold under contract. Clausing thinks it makes little sense to stimulate the The transition might be painful for some, but econo- economy by creating yet another deduction. Instead, tax mists like Ault believe that agricultural subsidies can’t work simplification and a reduction in corporate tax rates would in a global economy. “All countries are finding that, in the be better, she says. “You wouldn’t be handing well-connected face of foreign competition, subsidy programs are becoming people windfalls. You would generate economic activity more and more burdensome,” he says. RF

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JARGONALERT Sunk Cost BY ERIC NIELSEN

uppose the local theater is putting on a production go to the play or skip it. If you go, you will pay for the of your favorite play. In anticipation of the event, ticket and waste a few hours. If you do not go, you will still S you order tickets ahead of time for the second pay for the ticket and possibly spend the time doing some- performance. Unfortunately, your best friend sees the play thing more enjoyable or productive. No matter what you do, on opening night and tells you that it is awful and no one you pay for the ticket so it makes more sense not to go with any judgment would enjoy it. You now are in a bind and enjoy yourself instead. because the ticket you purchased is nonrefundable, and Though the above example may appear relatively harm- you really do not want to see the play. What should you do? less, the natural human tendency to consider sunk costs in Many people would go to see the play anyway, so as decisionmaking can have major policy implications. Just not to waste the price they paid for the ticket. This is a like people, businesses and government are often loathe to very natural psychological reaction that economists call admit they made a mistake, cut their losses, and start anew. “loss aversion.” People do not like to feel that they have This tendency to hold on to failing programs too long may spent money for no reason. However, natural as it may be especially acute in the public sector since the profit be, basing decisions on irrevocable past incentive is muted or nonexistent. expenditures is a classic Ultimately, if a business refuses example of the “sunk to admit it has made a mistake, cost” fallacy. it will go out of business or Economically become significantly less com- speaking, a sunk cost petitive. Governments face little is an expense that has or no such competition to already been incurred perform efficiently. and cannot be recov- The United States is cur- ered. For example, the rently engaged in military theater ticket above is action in Iraq — and there are a sunk cost because it has strong arguments from many already been purchased sides on how we should and cannot be refunded or proceed. For example, some easily resold. have argued that we should with- Advertising expenses are draw carefully from the region another example of a sunk cost. Let’s say you invest now, while others maintain that we should stay until the $1 million promoting a new product but find out that area is fully stabilized. It’s not clear which side is correct. few people are interested in actually buying it. You could What is clear, though, is that U.S. policymakers should continue to pump money into hawking the good — not weigh only the benefits and costs of leaving at the present wanting to admit failure — or you could move on and moment. The time and money that have already been spent promote a different product. Either way, you won’t be are sunk costs and should not be considered. It might be able to recover that initial $1 million investment. It is a best for us to stay, but the fact that we are already there is sunk cost. not a reason for us to remain. To argue that we should Sunk costs are contrasted with incremental costs. An finish what we started — no matter the consequences — incremental cost is one that will change with a particular would be to fall prey to the sunk-cost fallacy. course of action. For example, when you are at the grocery Costs are everywhere in life. Indeed, economics teaches store deciding what and how much to buy, the decision to us that they are unavoidable. So it is natural and rational purchase an extra loaf of bread involves an incremental to consider the costs of an action before proceeding. But cost. The expense of the bread will be incurred only if we should be careful to focus on those costs we can affect you decide to buy it. at the present — and not on the sunk costs that we have A rational economic actor considers only incremental already incurred. Focusing on sunk costs is ultimately costs when making a decision. It makes no sense to factor counterproductive and can only be justified through our in sunk costs precisely because they are sunk; no present psychological prejudices. Still, the urge to do so is strong, action can change them. No matter what happens, the sunk and explains why the practice is common among both costs are always there. In the theater example, you can either consumers and policymakers. RF ILLUSTRATION: TIMOTHY COOK

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RESEARCHSPOTLIGHT Is Good Journalism Good Business? BY DOUG CAMPBELL

n 2003, the Washington Post won three Pulitzer Prizes, In their new study, Logan and Sutter also look to the mar- more than any other newspaper in the nation save for the ketplace, this time for quantifiable answers about the appeal ILos Angeles Times, which also collected three. For the of quality journalism. They chose Pulitzers as their gauge on reporters and photographers whose names were on the win- the premise that the prizes bridge the gap between con- ning entries, the significance cannot be overstated: Pulitzers sumers’ and journalists’ perceptions of quality. They write: are journalism’s highest honor. The winners can expect greater “Pulitzer Prizes are a measure of quality as judged by jour- pay and prestige — and almost certain career advancement. nalists which consumers can easily observe and thus, provide The payoff for the Post as an institution isn’t bad, either. an opportunity to determine whether news consumers value Pulitzers may be a big part of the reason why the Post sells so what journalists consider high-quality journalism.” many papers — more than 1 million on Sundays to be exact, The results are compelling. Logan and Sutter examined the fifth highest total in the country. daily and Sunday circulation of the nation’s largest 400 news- In their recent article, “Newspaper Quality, Pulitzer papers in 1997. They found that papers which had won Prizes, and Newspaper Circulation,” University of Pulitzers during the preceding decade had “significantly high- Oklahoma economists Brian Logan and Daniel Sutter test er circulation, even when controlling for the economic and whether good journalism is also good business. Their study demographic characteristics and media competition of the shows that U.S. consumers have a healthy appetite for metropolitan areas.” In fact, daily circulation was found to be “quality” journalism. In newspapers, the authors conclude, 55 percent higher for Pulitzer winners than their empty-hand- quality still sells. ed counterparts. The top win- Journalism became an in- ners in the years from 1987 to creasingly ripe topic for eco- 1997 were among the 10 largest nomic inquiry in the 1980s and “Newspaper Quality, Pulitzer in U.S. daily circulation: the 1990s as media companies con- New York Times with 18 prizes, solidated their empires. There Prizes, and Newspaper Circulation” the Washington Post with 14, and were worries that profits would by Brian Logan and Daniel Sutter. the Philadelphia Inquirer with 11. come before quality. Sociologists Afew holes remain. In David Crouteau of Virginia Atlantic Economic Journal, claiming that the biggest are Commonwealth University and also the best, the authors William Hoynes of Vassar June 2004, vol. 32, no. 2, pp. 100-112. don’t explain the anomaly of College wrote that there was USAToday, whose unparal- increased “emphasis on revenue, leled growth has made it the margins, profits, and stock-price nation’s largest paper with performance, forcing the companies to emphasize the circulation of more than 2.2 million. At the same time, aspects of newspaper operation that directly produce those USAToday’s record in winning Pulitzers has been paltry, results.” Profit-maximizing media companies, the watch- with just one in its entire history. And as Logan and Sutter dogs warned, would seek to trim staff and deliver advertiser- note, USAToday is regularly derided in journalism circles friendly news — not the sort of “quality” attributes tradi- as “McPaper.” Nor do the authors address broader circula- tionally associated with the noble Fourth Estate. tion trends, in which even prize-winning newspapers are Sutter has looked at journalism through an economic lens losing eyeballs to cable TV and the Internet, which are not before. In a 2001 paper published in the Cato Journal, he always bound by the same standards as print journalism. addressed the conventional wisdom that the news media as a Still, Logan and Sutter make a strong case that publish- whole tilts left. While he concedes that there is good evidence ing good newspapers is good business. Papers that provide to support that claim — in surveys, a large majority of journal- quality content usually attract wider audiences, which ists at top media outlets identify as being left of center — it’s means greater revenue. More revenues don’t necessarily not clear that such bias is sustainable. That would require a mean more profitability, but it’s a fine start. “Quality may cartel — and cartels are notoriously unstable, with defection a well pay,” they conclude. “If quality produces a larger constant threat. In the case of the media, new technologies are audience, owners of media companies can rationally invest lowering the cost of entry, making it even easier for conserva- in quality journalism.” In a country that depends upon the tive voices to be heard. Over time, well-functioning markets free flow of quality information for the proper functioning should provide a wide variety of choices for media consumers. of its government and economy, that’s good news. RF

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SHORTTAKES

FINANCIAL AID “I think the beneficiaries of this will be the employees, the faculty, the students, and the institutions,” Payne says. Decentralizing Virginia’s “It seems to me they’re all winners.” Public Universities But not everyone feels like a winner. The Charter Initiative proposes big changes that will affect many parties, he budget crisis that swept through most state capitals and not all the changes will provide clear benefits. T the past three years took its toll on higher education For students, less state money means tuition may go up funding, pushing public universities to find ways to cope with considerably. However, all three universities plan to exercise budget shortfalls. Tuition rates have increased as much as some of their new freedom by implementing financial aid pro- 125 percent since 1990, and many institutions have sought grams that will meet the needs of their students. UVA, for additional funds through corporate partnerships. A few example, will introduce Access UVA, which university officials public universities have even privatized. expect will actually increase the number of Virginians The Fifth District is no exception. To counter a shrink- (currently two-thirds of the student body) able to attend UVA. ing state budget, the University of Virginia, the College of Jan Cornell, president of the Staff Union at UVA William and Mary, and Virginia Tech have engineered the (SUUVA), regards the Charter Initiative with little enthusi- “Commonwealth Charter Universities Initiative,” a legisla- asm. She has many reservations over the terms of future per- tive proposal that would grant the institutions more auton- sonnel policies if UVAbecomes chartered. omy in exchange for less state funding. “I understand the problem — the state is not giving them In other words, after the 2005 General Assembly, these enough money. I totally agree with that, but … I don’t think three public universities may get charter status — no [pulling away] is the answer to the funding problem. The rea- longer public, but not technically private, either. By giving sons for pulling out allow them to have freedoms that aren’t up a percentage of future state funding, a chartered uni- necessarily good for the employees.” versity would be granted greater freedom over its finances Cornell’s concerns are the result of observing em- — including the flexibility to raise tuition as its Board of ployee experiences at UVA’s Medical Center, which Visitors sees fit. Increased gained autonomy in 1996. autonomy also would signifi- “We’ve seen what happened to cantly reduce the inefficiency them. And that’s why we’re so and expense associated with against it now,” Cornell says. bureaucratic regulation. Tremendous turnover rates, Though they would no depressed wages, and inade- longer be state agencies, the quate working conditions are universities would not be pri- cited to have characterized the vate institutions either. years following the privat- According to Virginia Tech ization of the Medical Center. President Charles W. Steger, as The administration’s actions quasi-independent “political during the past year have failed University of Virginia’s famed Rotunda. A statue of subdivisions,” chartered univer- to alleviate Cornell’s frustra- Jefferson stands as a reminder of his founding ideal of an sities would remain “public “academical village.” tions that history may repeat institutions with boards of visi- itself. “When this all started, tors appointed by the governor, confirmed by the General Leonard Sandridge said that the employee input would be Assembly, and accountable to the commonwealth.” critical when they were writing the plan ... [but] nobody L. F. Payne, a member of the Board of Visitors at UVA, came to any employee or faculty member to find out what believes the Charter Initiative is absolutely necessary. UVA’s [we] thought about it before they wrote the plan.” state appropriation is “by far the lowest as a percentage of SUUVA’s worries are exacerbated because definitive any state university of the nation, and that number contin- answers concerning wages and working conditions are hard ues to decrease.” With charter status, UVA will better be to come by. “Unfortunately, there can’t be any guarantees,” able to meet future financial challenges, and “stay a top-qual- says Payne. “No one has enough information to be able to ity university and provide the high-quality education that say precisely what we can guarantee at this point. … But the kids in Virginia and other places are demanding. institution is no better than the people who are there … and PHOTOGRAPHY: CHRIS MYERS PHOTOGRAPHY:

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the idea is that [the charter] will … be able to improve the stood at 4.8 percent last fall. Dell said it chose the region compensation and benefits for employees.” not so much for the incentives package as it did for its Fortunately, UVAhas a second model of decentralization skilled pool of manufacturing workers and strategic loca- to draw on. With the approval of the “Financial Self tion. This gave rise to complaints that the Dell incentives Sufficiency” agreement, the Darden Graduate School of were overly generous, especially in light of news uncovered Business Administration gained financial autonomy from by the Raleigh News & Observer that a relatively small bid UVAin 1998, under the tenure of ex-dean Edward A. Snyder. by Virginia posed the only competition to North Carolina. “I can state for the record that the Financial Self Ray Owens, an economist at the Federal Reserve Bank of Sufficiency [agreement] we developed … was important, Richmond, has studied the wider issue of whether corporate and in my view, successful,” says Snyder, who is now dean incentives make sense. He came away with an answer that at the University of Chicago Graduate School of Business. may surprise critics of incentives: They can sometimes serve “Without this agreement, Darden could not have made the a greater good. Whether that’s the case with Dell’s deal in decision to grow its MBA program; it hadn’t done so in North Carolina won’t be known for a while. over two decades.” While some argue Darden’s goal is now Owens says that in some cases incentives can make a the pursuit of money at the cost of learning, there is no difference in luring companies to regions where workers are arguing with Darden’s performance in Business Week’s annual in desperate need of jobs, and as a result both the organiza- rankings of MBA programs; UVA has risen dramatically tion and the economically struggling community benefits. since the change. “Incentives can be costly, but you can end up with a net ben- “I know enough about UVA to say that reform is efit to the state and even nation as a whole,” Owens says. needed,” says Snyder. Where the matter gets fuzzy is in estimating both the According to Kevin Hall, Virginia Gov. Mark Warner’s deal’s actual costs and benefits in dollars. For starters, calling deputy press secretary, “The Governor … expects this to be the Dell agreement a $242 million package isn’t accurate, one of the more high-profile issues [in 2005] when the Owens says. The various perks being offered to Dell are legislature convenes. It’s a discussion that’s not going to be rolled out over 15 years, and in 15 years the value of a portion resolved quickly.” of those resources won’t be worth the same as in today’s There is a lot riding on the progress of the Charter pro- dollar terms. On the flip side, take with a grain of salt the posal. “[It is] such a fundamental shift in the status of the governor’s and Commerce Department’s assertion that new institutions which enjoyed world-class reputations based on taxes generated by the new plant will rise to $743 million. decades — if not hundreds of years — of support from the “I don’t think you can say out of hand that it’s a bad deal commonwealth of Virginia,” Hall declares. for North Carolina. At the same time, you can’t declare it a While a charter is certainly a method that holds a lot of slam dunk deal,” Owens says. “It’s not clear who’s right or promise for students, employees, and the commonwealth wrong. But it is fair to say that all these dollar estimates have as a whole, what remains to be seen is if these universities a lot of uncertainty associated with them.” — DOUG CAMPBELL can prove that their new financial freedoms won’t adversely affect Jefferson’s founding ideal of an “academical village,” HIGH-END HOLDOUT dedicated to the values of an open and diverse intellectual community. —JENNIFER WANG Northeast Textile Maker Finally Migrates South DOLLARS FOR DELL mid thousands of job losses in South Carolina’s textile Incentives Help Lure Company to A industry over the past decade, there is one small bright Winston-Salem spot on the horizon. Scalamandré, a New York City-based luxury fabrics producer that was one of the few textile firms omputer maker Dell Inc. grabbed headlines in North remaining in the Northeast, will be bringing 90 jobs to the C Carolina last fall for accepting what was billed as the Palmetto State this year. Many companies before it have largest incentive package in state history — $242 million in migrated south since the turn of the 20th century in pursuit tax credits, grants, and infrastructure improvements. In of inexpensive labor and other economic advantages. After return, the Austin, Texas-based firm promised to spend $100 75 years, Scalamandré is finally moving from an old brick build- million building a manufacturing plant on the outskirts of ing in Queens to a more modern facility in Gaffney, S.C., for Winston-Salem that will employ at least 1,200 people with- the same reason. in five years. (In addition to the state incentives, Dell was The company weaves silk and other fine materials into set to reap $37.2 million in local city and county incentives.) handmade fabrics, which are crafted into drapery, wall cov- The Triad metro area, of which Winston-Salem is a part, erings, upholstery, and other furnishings. Its products has been among the worst hit manufacturing regions in the adorn public and private spaces throughout the United nation, losing about 40,000 such jobs over the past decade. States, from the White House to the Metropolitan Opera Still, the Triad’s unemployment rate has not risen sharply; it House to Thomas Jefferson’s home, Monticello. Yet even

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a producer of such high-end, specialty textiles — some of INSOURCING which are sold to designers for as much as $2,000 a yard — eventually had to look at lowering costs and maximizing effi- Foreign Firms Set Up Shop in America ciency just as producers of commodity-type textiles have done for years. mid the alarm over the rampant outsourcing of Amer- For Mark Bitter, Scalamandré’s co-president, this meant Aican jobs to countries abroad, a lobbying group for relocating most of the company’s manufacturing operations foreign companies would like to call your attention to a out of New York City. “Our gross margins were such that we contrary trend: insourcing. could … tolerate the high labor and occupancy costs far better The Organization for International Investment (OFII) than most textile producers who make commodity-type pro- says that foreign firms employ 5.4 million people in this ducts,” Bitter says. But the company’s sales volume has fallen, nation, or 5 percent of private sector jobs. Four states in the partly due to a drop in luxury purchases after the Sept. 11 Fifth District rank in the top 20 for having the greatest terrorist attacks and partly due to growing global competition. number of jobs that are “insourced,” bankrolled by U.S. units “The only way we could compete effectively was by avail- of foreign companies. North Carolina has 212,700 such ing ourselves of the absolute best technology to produce the insourced occupations, the OFII says, placing it at No. 9 in finest quality at the lowest cost,” he says. “There is a limit to the country. Other top-rankers include Virginia (No. 13 with what even luxury buyers are willing to spend on products.” 146,400 jobs), South Carolina (No. 16 with 123,400 jobs) and Why didn’t Scalamandré just modernize its Queens Maryland, (No. 19 with 106,300). Not surprisingly, California facility? The company needed 150,000 to 200,000 square topped all states with 616,400 insourced jobs. feet of manufacturing space spread out horizontally on one The OFII claims that foreign firms pay U.S. employees level, but had only 115,000 square feet stacked on multiple “higher compensation than domestic U.S. firms.” They are floors. It couldn’t tear the existing building down or relo- also active in funding research and development, physical cate elsewhere in New York City because land is expensive facilities (which add to tax bases) and international trade and limited in supply, and (goods made in the United many commercial buildings States are de facto domestic are vertically oriented. exports, no matter that they In contrast, Gaffney and were made under the auspices other parts of Upstate South of foreign firms). Carolina have few densely “The bottom line is that populated communities, so insourcing companies improve there is plenty of open space. the performance of the U.S. For instance, the building economy,” writes Matthew J. that Scalamandré will move Slaughter, a professor at the into is a former textile facili- Tuck School of Business at ty measuring 350,000 square German automaker BMW’s manufacturing plant in Greer, Darmouth College, and author feet. And the company will S.C., has created 17,000 jobs, directly and indirectly, since of the OFII’s report. “It is save 60 percent to 70 percent opening in the mid-1990s. important that government on its occupancy and related expenses, according to Bitter. officials and the business community understand the contri- He also expects to reduce per-unit labor costs by 40 bution of insourcing companies, and that these officials percent. Most of the Queens facility’s laborers had worked formulate policy accordingly.” there for 10 years or more, putting them at a higher union In other words: Don’t make it harder for foreign firms pay rate. Moreover, the Gaffney facility will tap into a to locate here. Among the policy recommendations OFII labor market in Cherokee County where the unemploy- presses at the report’s conclusion is to ensure equitable ment rate last September hit 9.6 percent, almost three treatment of insourcing companies. “For insourcing com- points higher than the statewide rate. panies to continue expanding in the United States, they However, even Bitter knows that these cost savings may must know they will receive nondiscriminatory treatment not be enough to keep his company from turning to outsourc- under U.S. law.” Equally, the group calls for liberalized ing overseas. Scalamandré will also have to continue to inno- trade and investment rules. Otherwise, OFII warns, the vate and improve the quality of its goods. As for textile work- United States could lose many of these insourced jobs to ers in South Carolina, they will have 90 more jobs available to India and China. Sound familiar? keep them in the industry that is in their blood. But while that Back in the late 1980s, University of South Carolina employment figure could double in the future, it still falls economist Douglas Woodward co-wrote a book about short of the 480 positions that used to exist at the Gaffney insourcing called The New Competitors: How Foreign plant before National Textiles shut it down in 2001. In short, Investors Are Changing the U.S. His conclusion then and now economic forces will continue to challenge America’s textile remains the same: Insourcing is imperative in a time of industry to be leaner and meaner. — CHARLES GERENA outsourcing, and there are few disadvantages to having PHOTOGRAPHY: BMW MANUFACTURING CORP. BMW MANUFACTURING PHOTOGRAPHY:

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foreign companies employ U.S. workers versus having U.S. land economist who contributes to the Chesapeake Bay Com- companies employ them. mission’s Blue Crab Technical Work Group. “They have to “Multinational corporations have competitive advan- survive that and get back into the bay, find nursery grounds tages they can bring to an area that certainly go beyond and survive being eaten by all sorts of fish in order to become job creation,” Woodward says. “They bring in new man- an adult.” agement expertise and techniques. They infuse a region Therefore, any effort to restock the blue crab population with more competitive practices. Every area successful in has to go beyond just hatching eggs, dumping larvae into the world, from Ireland, Singapore and even less devel- the ocean, and hoping for the best. Japanese scientists oped nations like Costa Rica — for them foreign direct released tens of millions of larvae to boost the number of investment has been a major driving force in moving their swimming crabs for almost 20 years, until they realized that economy forward.” it probably wasn’t working. In the 1990s, they started raising In South Carolina, the 1992 decision by German crabs to an older age before releasing them in order to give automaker BMW to build a plant has resulted in 17,000 them a better chance of staying alive and breeding. jobs, directly and indirectly, Woodward says, somewhat Along with the Smithsonian Environmental Research offsetting the painful losses in local textile jobs to low-cost Center (SERC) and the Virginia Institute of Marine Sci- countries and new technology. ences, researchers at the Center of Marine Biotechnology The large appetite of U.S. consumers serves as potent (COMB) in Maryland took this second step from the very draw to foreign firms but more can always be done. Providing beginning. Using its expertise in spawning, production educated and skilled workforces along with good roads, biology, and the early life stages of marine organisms, airports, and sea ports is crucial, Woodward says. Strong COMB converted a basement in downtown Baltimore into incentive programs can also make a difference, he says. a carefully controlled environment where female blue crabs And then there’s the sliding value of the U.S. dollar. “If I can hatch eggs and the larvae can develop into 2-month- were a state or local economic development official, I’d be old juvenile crabs. beating down the door in Europe to say look at how cheap Juveniles are less than an inch in length and have soft, it is to get into the U.S. market,” Woodward says. “If they translucent shells. Since they have bypassed a tough part want to take advantage of this opportunity, there couldn’t of their lives in captivity, however, more of them are around be a better time.” — DOUG CAMPBELL to progress from adolescence to sexual maturity. In the last three years, 100,000 juveniles have been released into BLUE CRAB RANCHING the Chesapeake Bay. They appear to have a similar survival rate from adolescence to breeding age as native crabs do. Restoring the Chesapeake Bay’s Most Whether helping nature along will replenish the bay’s blue Valuable Commodity crab population remains to be seen. The effectiveness of Japan’s restocking efforts has been difficult to gauge due to ifth District researchers are pursuing a new approach to a lack of data. To judge the progress of blue crab restock- Fhelping the blue crab, a symbol of the Chesapeake Bay ing, SERC scientists tag juveniles and track them for up to and its most valuable seafood product. By boosting the bay’s 14 weeks after their release. breeding stock with young crabs hatched and raised in cap- If the restocking approach works, the next step is to tivity, they hope to reverse a decades-long decline in the modify it so that watermen throughout Chesapeake country overall crab population. If their experiment succeeds, can raise crabs and release them on their own. Getting them watermen in Maryland and Virginia could take nature into on board will require continued confidence building on the their own hands to help safeguard their economic futures. part of scientists, though. Watermen are traditionally fatal- Restocking programs have been ists who believe that nature governs the used to revive marine populations Wa termen may soon cultivate and release workings of the bay. these juvenile blue crabs to restock the many times, from salmon on the West Chesapeake Bay. Could watermen be right about Coast to trout in the Great Lakes. But letting nature take its course? Allow- such programs are rare for crustaceans ing the total supply of blue crabs to and other species with a high rate continue to fall would put upward pres- of reproduction. Since their offspring sure on prices, which would eventually have a low probability of survival, reduce the quantity of crabs consumed these creatures produce millions of and level off the amount of harvest- larvae, thus making any restocking ing. “That is the market working. But effort difficult. what’s happening with the biology? “Blue crabs spawn in the southern At that point, have you gone past part of the bay and the eggs are hatched some critical level where the [blue offshore in the [Atlantic] Ocean,” says crab] stock will take years to rebuild?” Douglas Lipton, a University of Mary- asks Lipton. — CHARLES GERENA PHOTOGRAPHY: COURTESY OF UMBI COURTESY PHOTOGRAPHY:

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branchbonanza Bank branches, all but given up for dead a decade ago, have kept on growing in numbers through 2004. Analysts say that location, accessibility and even architecture are the keys to a branch’s success in collecting deposits.

his swath of real estate in Lees- What’s surprising about this scene They cost a lot, burg, Va., has everything you is that technological advances were T would expect in one of the supposed to make bank branches but customers can’t get country’s hottest job and population extinct. The telephone, the Internet, markets: upscale strip malls and and souped-up ATMs — these were enough of them. Why bank low-slung office buildings; construc- the devices through which retail and tion signs and sprawling town-home even some commercial customers branches won’t go away complexes. would interact with their banks. Bricks But there’s one feature that crystal and mortar cost too much to build and BY DOUG CAMPBELL ball gazers of the 1990s might not have staff; customers would grow accus- guessed: bank branches. There are tomed to conducting transactions in nine of them within a half-mile of each the virtual world. other in this Washington, D.C., sub- It didn’t happen that way. Across urb, together keepers of almost $600 America, more branches are opening million in deposits. than ever — some 2,000 were added ANDER COMMERCIAL PHOTOGRAPHY/WACHOVIA/NEWPORT NEWS/600 THIMBLE SHOLS LLC THIMBLE SHOLS LLC NEWS/600 PHOTOGRAPHY/WACHOVIA/NEWPORT ANDER COMMERCIAL

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just last year. Industry giants Bank of to hand out the finest toaster, banks are generally finding it profitable to do America and Wachovia Corp. have would compete on price. so, and that’s a little different than what unveiled plans to build hundreds of new Contrary to expectations, branch was expected 10 years ago.” branches in new and existing territo- banking continued to grow. State Profitable and then some. Banks ries. As much as bankers would have branching laws were slowly being with more branches are also the most liked to have stopped building new relaxed in the 1980s and 1990s. In efficient — but not because of offices, darn it if customers didn’t 1994, the Riegle-Neal Interstate economies of scale. The FDIC and demand them. Nothing beats the con- Banking and Branching Efficiency Federal Reserve researchers have identi- venience of a neighborhood branch. Act removed remaining state restric- fied increased revenues, as opposed Leesburg encapsulates the rising tions on interstate branching. In addi- to reduced costs, as the driver behind fortunes of bank branching. Instead of tion to opening the door to buying efficiency improvements (as measured seeing branches close their doors in the out-of-state institutions, banks could by the so-called “efficiency ratio,” which past decade as banks merged, more enter new territories with newly char- is calculated by dividing noninterest branches have opened (although that tered “de novo” offices. In the 1980s expenses by the sum of net interest growth turns out to be anomalous in alone, more than 15,000 branches income and noninterest income). From the Fifth District, a point that we’ll were added in the United States. 1970 to 1990, efficiency ratios among address). Be they big or small, the banks Then came branch banking’s sec- U.S. commercial banks were relatively that have found the most convenient ond, and seemingly more threatening, flat, the FDIC found. They began to locations here have been the most like- death notice. This time the killer was improve (fall) as the number of banks ly to ring up market-leading positions to be technology. Voice mail trees, declined (with mergers) and the num- in deposits. Branches are central to a ATMs, and the Internet would make bers of branches grew. bank’s success. full-service branches a thing of the past. Branches may be costly, but they’re The enduring appeal of garden- Pure-play Internet banks started a good place to generate revenue. variety banking offices holds a lesson: sprouting up, fueled by enormously Allen Berger, a senior economist with Just because there’s a supply of new, efficient cost structures. But they the Federal Reserve Board of cost-efficient technology doesn’t mean lacked a human touch. Most of these Governors, and Loretta Mester, direc- there’s an immediate demand. This is Internet banks failed to make the tor of research at the Philadelphia Fed, not to say that change isn’t coming. impact once envisioned, says Elias report in a 2003 paper that banks got Online services like bill paying and loan Awad, the Virginia Bankers Association so good at selling during the 1990s applications are slowly catching on. professor of bank management at the that they easily offset rising expenses, The shift is just taking a little longer University of Virginia. “People couldn’t such as larger branch networks. “Over than anticipated, and it’s being accom- see themselves having money in an time, banks have offered wider variet- plished mainly because of hand-holding artificial environment,” Awad says. ies of financial services,” they wrote. from front-line branch employees. So instead of a virtual banking “In addition, banks have provided “There was a feeling, back when the boom, the growth came in bricks and additional convenience.” Internet craze was going on, that con- mortar. The number of bank offices Phelps says, “People pay attention sumer behavior was going to change, climbed 10.5 percent in the past decade to costs, but it’s on the revenue side and banks wanted to be out in front of to 89,814. Over the same period the where the clear gains are being made.” that curve,” says Terry Meyer, president average number of offices per bank Even small banks are finding profits of the Raleigh-based consulting firm leaped from 6.3 to 9.5. All this happened in branches. In its branching study the MarkeTech Systems International. amid rampant banking consolidation, FDIC defined small banks as those with “They wanted to pull cost out of the with the number of banking institu- less than $1 billion in assets. It found distribution system. That change was tions declining almost 50 percent from that banks with more branches were greatly exaggerated.” 1994 to 2004. And it happened despite more efficient — that is, they were able the strong incentives banks had to curb to produce an additional dollar of rev- Premature Death Notices branch growth. A typical branch costs enue at lower cost. According to the Branch banking obituaries started between $1.5 million and $2.5 million to FDIC, banks with 11 or more branches appearing in the 1980s. Lawmakers in build and then runs up to $800,000 a were the most efficient of the small 1980 lifted Depression-era rules (called year to staff and maintain. banks, followed by those with between Regulation Q) that had placed ceilings It’s a sizable investment, but the 10 and four branches, which in turn on the interest rates banks could offer payoff is clear. “The economics of it are were more efficient than banks with on savings accounts. One school of that it makes sense for banks to three or fewer branches. Meanwhile, thought was that bank branches would branch,” says Jack Phelps, acting overall bank efficiency ratios have have fewer reasons to exist in an envi- director for regional operations at the improved by about 30 percent over the ronment with no lids on deposit rates; Federal Deposit Insurance Corporation last 20 years, a period that coincides instead of competing branch by branch (FDIC). “The people who are doing it with branching expansion.

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Additionally, the FDIC CEO, sized up the opportu- has found that banks of all nity and said: “I just want sizes post higher returns that $100 million.” In five on equity if they have more years, he got it, and he didn’t branches (see chart on have to pay a premium for page 17). another bank to do it. Last year, the Leesburg office, Super Sites which opened in January The economic success or 1996, had $140 million in failure of individual branch- deposits, most in the city. es is almost all about geo- Loudoun County is graphy. something of a no-brainer MarkeTech analyzed the as a place to open a bank performance of 5,000 young branch. Since the dawn of branches in the United the 1990s, the county has States, defined as those Middleburg Bank’s branch in Leesburg, Va., is the fastest-growing seen population grow at a around for about 10 years. and biggest banking office, with more than $140 million in robust 7.5 percent annual clip, The key finding was that 70 deposits, in fiercely competitive Loudoun County. the second highest rate in the percent of a branch’s success nation for that period. For or failure in collecting deposits was analysis, the top performers in “static” the 12 months ending March 2004, explained by micro-market variables: markets outdid the top performers in Loudoun County posted a 5.5 percent What other retailers were situated high-growth areas. gain in jobs, sixth fastest in the nation nearby? What competitors were there? and shattering the U.S. employment How convenient was it to get in and Middleburg Branches Out growth rate of 0.8 percent. The region out? Were there traffic lights? How Which brings us back to Leesburg, Va. has benefited as a bedroom communi- dense was the immediate population? According to a MarkeTech analysis, ty of Washington, D.C., and is home to The upshot: MarkeTech estimated Middleburg Bank’s Leesburg branch many government contractors. New that location explained up to 55 percent accomplished the rare feat of being jobs mean new homes and new retail- of deposit formation. About two out among the top performers of all ers, which in turn mean mortgages and of three banking customers live with- branches in the Fifth District as well commercial loans. in two miles of their principal branch. as being located in one of the nation’s Middleburg Bank’s Leesburg branch That’s it, folks. Location. Straight fastest-growing markets. on Catoctin Circle is strategically locat- out of a circa 1950s real estate how-to It took 70 years for Middleburg ed near the Dulles toll road, with easy manual. Location. Bank — based in Middleburg, Va., a access to neighboring housing units and The Federal Reserve has studied why Loudoun County community near not far from downtown. Nan Havens, people choose their banks and came Leesburg — to become a convert to manager of the branch, explains the back with that same answer. “The single the virtues of branching. In 1994 it success: “Location, location, location,” most important factor influencing a cus- still kept only its headquarters office Havens says. “It’s perfect.” tomer’s choice of banks is the location and had $110 million in total deposits of the institution’s branches,” said for 12.9 percent market share, making In The Flesh Federal Reserve Governor Mark Olson it a distant third in Loudoun County. For now, technology is a lousy tool for in a May 2004 speech. Ranking “loca- At the end of June 2004, the latest accumulating deposits. People are tion” highest in their decisionmaking date for which aggregate records are much better. Branching has allowed were households (43 percent) and small available, Middleburg rode its five Middleburg Bank to situate its peo- businesses (30 percent), according to offices to deposits of $418 million, ple within convenient distance of its Fed surveys in 1998 and 2001. claiming 18.46 percent of the county’s customers. But bankers should follow their market, moving up to a solid hold on The revolutionary strategy: It’s intuition only so far. Retailers instinc- the No. 2 spot in the county. easier to sell people products if tively might want to seek out high- The Leesburg market opened up in a) you’re talking to them face-to-face; growth and affluent areas, but in the mid-1990s as community banks and b) you already do business with branch banking that doesn’t necessarily Farmers & Merchants of Hamilton them. Likewise, it’s even easier if equate to performance. “Banks go to and Bank of Loudoun were gobbled up you’ve found the perfect spot for your growth. They think that’s where they’ll by bigger banks. Those two banks branch, as Middleburg Bank seemingly be most successful,” MarkeTech’s commanded $100 million in deposits, did in Leesburg. Meyer says. “But the problem is every- or almost a third of the market. “My belief is that if you can put a body goes there.” In MarkeTech’s Joe Boling, Middleburg’s chairman and strategically placed financial service PHOTOGRAPHY: JANET DEWEY/MIDDLEBURG BANK/LEESBURG JANET DEWEY/MIDDLEBURG PHOTOGRAPHY:

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center in a core part of a market and for a coffee bar, but it’s not here yet. Big Banks Lead The Way you have the right people and the But it works. Branch employees In Leesburg, the city’s second-biggest right services, they will come,” says open about 150 new accounts a branch, with $137 million in deposits, Boling. “We’re building relationships, month, Havens says, and about half is located directly across the street not just counting deposits.” of those are for existing clients. In from Middleburg Bank. It belongs to Pacing through the carpeted other words, checking account cus- North Carolina-based BB&T. office, branch manager Havens greets tomers are also signing up for insur- Where Middleburg Bank has used several customers by first name. ance, investments, and other finan- a rifle approach to branching, BB&T’s Contractors clad in overalls and cial products. “We’re doing a lot has been more shotgun. It has pocked mothers toting babies in car seats ease of cross-selling,” Havens says. “The the county with 12 branches, producing up to the teller stand. At 11 a.m., all buzz word for now is relationship a market-leading $524 million in three drive-through teller lanes are banking.” deposits, or a 23 percent share. BB&T occupied with cars. “Folks who thought it was going to didn’t build its Leesburg office; it was There is very little unique about go away completely forgot that they one of the prizes in the 2001 purchase the space. A basket of toys sits to the needed some touch points,” Boling of Farmers & Merchants of Winchester. side of the teller lines for restless says. “We still like to see each other Rip Howard, Virginia market children to play with. There are plans and we still like to shake hands.” president for BB&T, says aggressive

Bank Bait?

Banks across America are waking up to realize that “retail a normal card. Not satisfied? No problem — ask your local appeal” has become vital in the increasingly competitive Bank of America branch about its “Photo Expressions” banking industry. Banks are now attracting customers by program, a way of reliving your Kodak moments each time you introducing new technologies and branch designs. swipe your credit card. Photo Expressions allows the cus- Tony Plath, a finance professor at the University of North tomer to have any image of their choice printed onto their Carolina at Charlotte explains that nationwide, banks realize card, whether it is a pet or favorite vacation spot. that “their business is in retail also, with a slightly different This advent of technology must also be engaging for the product.” In this case, the products banks offer are hooks, ways customer. As Hamerman explains, “We’re trying to be to get the customer to linger and hi-tech, but also hi-touch.” This buy something they ordinarily concept is at work in SunTrust’s would not have. It is the banking new drive-up system. Highly equivalent to placing candy bars interactive, the customer in lanes next to the checkout. not directly next to the window is The hooks come in different now able to communicate with forms. For many banks, it starts the teller via video. with atmosphere. Increasingly, Bank of America isn’t the only bank lobbies are beginning to look bank employing retail tools. like hotels, with long mahogany BB&T has a plus package that counters and couches inviting the offers rewards to customers, such customer to stay awhile. In fact, in as coupons toward travel and Annapolis, Md., BB&T even con- entertainment. Since so many verted a house into a branch, fos- banks are employing these tech- tering a feeling of familiarity. Some bank interiors have developed a look more like hotel niques, what ensures a successful Garnett Hamerman, a senior vice lobbies with an inviting “stay for a while” atmosphere. program? Tony Plath suggests that president at SunTrust, uses the the answer lies in offering “a pro- bank’s new Richmond, Va., branch as an example: “Everything is motion a customer wants to buy. Some promotions are just designed to appear more open and light.” Gone are the closed- bad. … Rewards really encourage frequent use of a product.” off cubicles and offices, with glass doors and open kiosks taking What all these promotions and inviting atmosphere really their place. boil down to is a good use of space. Banks must consider who Some banks are also offering a winning combination of they are trying to attract and where they are located. technology and marketing. For instance, last year Bank of One thing is clear: With the rapid advance of technology America, which has pioneered many of these innovations, and a generation that has come to expect it, banks will introduced the first “keychain credit card,” offering all continue to market themselves to new customers. It’s a the features of a regular credit card, but at half the size of matter of survival. —JULIA R. TAYLOR PHOTOGRAPHY: STEVE BUDMAN/TOWNEBANK/GREENBRIAR BANKING CENTER/CHESAPEAKE/HBA ARCHITECTURE, BUDMAN/TOWNEBANK/GREENBRIAR ENGINEERING & INTERIOR DESIGN STEVE PHOTOGRAPHY:

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branching works in Leesburg because Virginia added to its banking net- happening because Texas was a unit- it’s the best way to lure the bank’s work in the decade up to June 2004. banking state, where branching was bread-and-butter customers — indi- The lack of branching growth in outlawed. “It was never a fair con- viduals and small businesses. “Their most of the Fifth District is attributa- test,” Davis says. choice of banking is the branches,” ble to long-standing liberal banking The quirkiest trend was in Howard says. “They say they want laws in those states. North Carolina’s Wa shington, D.C., which lost about branches, that’s where they want to do first bank branch opened in 1804, and 20 percent of its branches in the their business. That’s driven us to the competitive intrastate banking decade up to 2004. The FDIC’s build branches.” environment has produced a state that Phelps is unsure why this has hap- You might think BB&T would be is second only to California in terms pened, but says that one factor is prob- looking to thin its branching ranks in of branches per capita. ably consolidation, which caused Loudoun, but Howard doesn’t see it As a result, the Fifth District has banks to close redundant offices. that way. He cites a recent survey that developed into a banking power- Additionally, the FDIC found that suggested small business clients visit- house, analysts say. Charlotte is home economic factors have strong influ- ed their branches 4.5 times a week. “I to Bank of America and Wachovia, ence over a region’s branching activity, honestly think there is a certain Nos. 3 and 4 nationally by assets, and and D.C. ranked last among U.S. states comfort level and feeling of security” No. 14 BB&T is based in Winston- for average employment and popula- that customers get in branches, Salem. Having learned how to survive tion growth between 1994 and 2003. Howard says. “I don’t know if you in a free-for-all branching climate, More generally, D.C. might reflect a totally get that feeling on the tele- North Carolina banks in particular trend of branch density falling in phone or using online computers.” were adept at cross-state branching cities while rising in suburbs. “A t one time, it was thought branch- as soon as it became legal to do so. es would be dinosaurs. The only people “There’s no doubt that statewide What’s Next? who didn’t believe that were the branching made North Carolina High-tech branches may have sex clients,” Howard says. banks very aggressive and very com- appeal, but they haven’t proven them- petitive,” says Harry Davis, finance selves to be any more profitable, ABranch Boom, But Not Here professor at Appalachian State Meyer says. “We haven’t found a lot of While branch banking is booming in University in Boone, N.C., and an things to correlate [performance] Leesburg, in other parts of the Fifth economist for the North Carolina with inside-the-branch décor or District things are quite different Bankers Association. “And another things of that nature,” he says. More (see chart below). Despite the strong very important thing it did was important are branch hours, visibility tie between branching and sales create larger banks with layers of and the retail characteristics of the growth, banks for the most part in middle management.” That meant branch’s neighborhood. the Carolinas, Virginia, and Maryland that North Carolina could send its MarkeTech consultant Hal Hopson were putting on the brakes in brick managers to locales like Texas to run sees a lot of phone banks andInternet and mortar expansions. Only West their banks, but the opposite wasn’t consoles growing cobwebs at bank branches. “The high-tech, whiz-bang stuff doesn’t get a lot of use,” he says. Branching Goes Boom None of this is to conclude that The number of bank branches in the United States grew by 8,510, or 10.5 percent, from virtual banking offerings aren’t taking 1994 to 2004, defying projections that technological advances would spell death for hold. In 2004, an estimated 7.3 percent branch banking. But the trend wasn’t evident in the Fifth District, where there are now of banking transactions took place 200 fewer bank offices compared with a decade ago. The lack of branching growth in online, according to industry consult- the District is largely attributable to long-standing liberal banking laws in the region. ant TowerGroup. Next year, almost 100 one out of every 10 transactions is ) 90 expected to happen over the Internet. 80 A recent American Banker/Gallup sur- 70 60 vey found that 30 percent of U.S. con- IN THOUSANDS ( 50 sumers now pay their bills online and 5th Total 40 U.S. Total most of those were very satisfied with RANCHES B 30 their service.

OF 20

. Home mortgages are easily ob- O 10 N 0 tained over the phone and Internet, 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 and firms not bound by bricks and SOURCE: FDIC; Yearly totals ending June 30 mortar are discovering new ways to translate lower costs into landing

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customers. Capital One Financial, the McLean, Va.-based credit card Bigger = Better company, bills itself as “America’s A Federal Deposit Insurance Corp. study found that banks with more branches tend to largest online vehicle lender.” Its deliver the highest returns on equity (ROE), an important measure that gives a general Web site can approve applications indication of a company’s efficiency. Technically, ROE is equal to a year’s after-tax income within minutes and deliver “blank divided by book value, expressed as a percentage. checks” for buying cars by the next day. And since it doesn’t have to 15 build and maintain costly branch 10 offices, Capital One’s auto lending ROE business can undercut interest VERAGE

rates offered by banks and credit A 5 unions. Some financial institutions have 0 proven you don’t need branches. 12 to 3 4 to 10 11 to 30 >30 NetBank, one of the first online-only NUMBER OF OFFICES financial services companies, is prof- SOURCE: FDIC; Figures as of June 30, 2004 itable and growing, with a strong mortgage banking business. At the same time, NetBank’s biggest draw- electronic banking and have less customers click away [from the back may be its lack of physical need for an on-site visit to a bank,” site],” Awad says. “People are still presence. Last fall, at least one invest- Davis says. “But right now, there’s sensitive about something that they ment bank lowered its stock rating still a very large percentage of bank consider personal.” for NetBank in part because so much customers who want to go talk to a Now industry observers think the of its business is derived from highly person face-to-face. That percentage building spree is nearing its end. competitive wholesale and correspon- has surprised everyone by its size.” Having fleshed out their retail net- dent channels — not retail-oriented Awad, the University of Virginia works with bricks and mortar, banks branches, like many of its rivals. professor, says banks possess far in 2005 and beyond will start concen- Recognizing the power of bricks and more sophisticated technology than trating on training their customers mortar, E*Trade Financial Corp. — customers to date have shown a will- to use more of the technology avail- which started as an online stock- ingness to try. Part of that is simple able at their branches. The future trading firm — has begun opening aversion to change; part of it is a very is expected to be full of offices that branches, most recently in Chicago. real aversion to giving up personal are staffed with fewer employees, E*Trade’s branches do more than just information over online channels. making them more cost-effective. In court stock traders; they offer compre- Awad describes a standard pitfall for an industry based on rules, regula- hensive financial services, including banks that offer loan applications on tions and standardization, branches checking and lending. their Web sites. Many customers get in fact offer banks their best vehicles We’re ending up with institutions to the point of downloading the for customizing products and servic- that operate in both the real and the form, but when it comes to keying in es to specific customers. “Branch virtual world. their Social Security numbers, they banking is growing, but it’s with the “Clearly as we go through time, balk. “When they were asked for sen- idea of becoming as fully automated more and more people will use sitive information, more and more as possible,” Awad says. RF

R EADINGS Berger, Allen N., and Loretta J. Mester. “Explaining the Dramatic Olson, Mark W. “Remarks at the Fortieth Annual Conference Changes in Performance of U.S. Banks: Technological Change, on Bank Structure and Competition,” sponsored by the Federal Deregulation, and Dynamic Changes in Competition.” Journal Reserve Bank of Chicago, May 6, 2004. of Financial Intermediation, January 2003, vol. 12, no. 1, pp. 57-95. Seale, Gary. “Branching Continues to Thrive as the U.S. Banking Hirtle, Beverly, and Christopher Metli. “The Evolution of U.S. System Consolidates.” FYI: An Update on Emerging Issues in Banking Branch Banking Networks: Growth, Consolidation, and Strategy.” Series, Federal Deposit Insurance Corp., October 2004. Federal Reserve Bank of New York Current Issues in Economics and Spieker, Ronald L. “Bank Branch Growth Has Been Steady — Finance, July 2004, vol. 10., no. 8. Will It Continue?” Future of Banking Study Series, Federal Deposit Jayaratne, Jith, and Philip E. Strahan. “The Benefits of Brancing Insurance Corp., August 2004. Deregulation.” Federal Reserve Bank of New York Economic Policy Visit www.rich.frb.org/pubs/regionfocus for links to relevant sites. Review, December 1997, vol. 3, no. 4, pp. 13-29.

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SM the conferenceshuffle

The Atlantic Coast n the fall of 2001 it was George Nemhauser’s turn to serve as pres- I ident of the Atlantic Coast Conference set off a Conference. Ordinarily this would be no big deal. The position of ACC pres- ident unceremoniously rotates each wave of league swaps. year among league faculty representa- tives. They tend to brand their terms with lackluster pet projects like sports- Despite the outcry, manship or raising academic standards. But Nemhauser, a professor at Georgia Tech’s industrial and systems it shouldn’t have engineering department, had a gut feeling that the nine-school ACC was at a crossroads. So when ACC Com- surprised anyone missioner John Swofford asked the question — “What’s on your agenda?” — Nemhauser didn’t hesitate: “We BY DOUG CAMPBELL need to think about expansion.” And thus was set in motion the events that led to a seismic shift in athletic conference memberships across the National Collegiate Athletic Association (NCAA). By the fall of 2003, the ACC’s historic and some- times tumultuous march to expansion was complete. Ultimately accepting invitations to join the ACC were three schools: University of Miami, Virginia Tech, and Boston College. The three From Top to Bottom: jumped from the Big East, setting off 1) 2004 Atlantic Coast Conference Logo a nationwide chain reaction of con- 2) John Swofford, ACC Commissioner ference swaps. In all, 19 schools 3) Miami vs. VA Tech, 12/4/04 switched leagues during the second 4)Duke vs. UNC, 2/5/04 half of 2003, and some analysts believe 5) Jessica Trainor (Virginia) and more shuffling is to come. Anne Morrell (North Carolina) at the In the aftermath, ACC leaders were 2004 ACC Women’s Soccer Game giddy. “We have landed at a superb PHOTOGRAPHY: TOP TWO IMAGES COURTESY OF ACC/BOTTOM THREE IMAGES BY JEFF CAMARATI/GETTYIMAGES BY THREE IMAGES OF ACC/BOTTOM COURTESY TWO IMAGES TOP PHOTOGRAPHY:

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place,” Swofford said during a June 2003 actions are in keeping with microeco- The ACC hired sports-business con- press conference to announce the first nomic models of how competitive sultant Dean Bonham to conduct an phase of expansion. In short order, the industries work. analysis of expansion’s pros and cons. ACC had enhanced its revenue-gener- “You can’t hold back these market Bonham’s answer, contained in a report ating prowess in football while at the forces,” says Raymond Sauer, an econo- that was a year in the making, was a same time preserving its reputation as mist at ACC member Clemson robust recommendation for adding the premier men’s basketball confer- University and keeper of the Web-log three schools. In Bonham’s analysis, ence. Television contracts were quickly www.sportseconomist.com. short-term monetary gains were sec- renegotiated to reflect the addition of ondary to the pressing task of durability. the Boston and Miami markets, Nos. 6 Why It Happened “The bottom line came down not and 17, respectively in the nation, adding Pop quiz: The ACC is expanding from to money but survival,” Bonham says. millions of dollars to the ACC’s take. nine member schools to 12 because: “The ground underneath the collegiate This fall the ACC will hold its first- a) Miami couldn’t fathom hosting a world was moving at a pretty rapid ever football championship, worth an home football game against lightweight rate. We foresaw there was going to estimated $7 million. And it stands a Big East foe Rutgers. be a lot of alignment and realignment. far stronger chance of placing two b) Newly struck television contracts If the ACC didn’t expand, some of schools in the coveted Bowl Champi- will bring the ACC an estimated extra their competitors or other conferences onship Series (BCS), whose title game $16 million each year. would.” is worth as much as $14 million and c) ACC leaders feared that Florida The collegiate map that Bonham lesser matchups not far behind. State would leave if Miami was gobbled and ACC managers analyzed in 2002 Meanwhile, the Big East was in up by the Southeast Conference (SEC). laid bare the need for action. Out of crisis, reeling from what Commissioner Answer: All of the above. 11 Division 1-A conferences, the ACC Mike Tranghese had called “the most At one time, all the ACC’s schools ranked fifth in total revenue-per-school, disastrous blow to intercollegiate ath- called the Fifth District home. Estab- according to an NCAA study (see table letics in my lifetime.” In the space of lished in 1953 with eight schools, the on page 22). On an average, per-school a few months the Big East became Greensboro-based ACC lost charter- basis, the league was losing money, the Medium East, having lost three of member University of South Carolina albeit just a bit. Additionally, the ACC its highest-profile schools. Suddenly, in 1971 to the SEC but added Georgia relied heavily on men’s basketball for it was scrambling to survive with only Tech in 1978 and Florida State in 1991. revenues, which would have been fine six teams playing football. In Georgia Tech, the ACC laid claim except that football generally pays a lot The media portrayed the story in to the valuable Atlanta TV market; in more. The bigger conferences, espe- multiple ways. Some said it was a case Florida State, it finally claimed a top- cially the SEC and the Big 12, gained of brilliant strategy by the ACC con- tier football team. much more from their football pro- trasted by the flat-footedness of the The 1990s and beyond have been grams. While the ACC took in an Big East. Others saw it as an example good years to the ACC. Basketball average $8.1 million per school for of greed overtaking amateur sports. powerhouses Duke University, Univer- men’s basketball and $11.8 million for Neither turned out to be a fair sity of North Carolina, and University football, the SEC generated $5.7 million characterization. Interviews with econ- of Maryland won championships, from men’s basketball and a whopping omists and NCAA observers suggest earning the league a deserved distinc- $26.9 million from football. that conference realignment was going tion as the best in hoops. And Florida Where does all that cash come to happen, whether or not the ACC State took home the No. 1 football from? TV and radio revenues from con- led the charge. Powerful market forces ranking for the 1999 season. tracts negotiated by the schools were at work, creating incentives for Nemhauser’s hunch — shared by themselves account for 7 percent of athletic leagues to grow membership. observers across the country — was that Division 1-A athletic program support. What’s more, the Big East was time was running short for conferences Another 9 percent is from NCAA and hardly asleep at the wheel. Big East to shore up membership and protect conference distributions. Most of that leaders in the late 1990s and in May their goodies. But if it were to go money — an estimated 90 percent — 2003 approached the ACC about through with enlargement, the ACC comes from broadcast agreements merging their football leagues. On both would be making a huge bet. The league negotiated by the NCAA and the ath- occasions it was the ACC that said ‘no,’ annually pays out about $9 million to letic conferences, such as the $6 billion, in the end deciding to cherry-pick some $10 million each to its member schools, 11-year pact allowing CBS to broadcast of the Big East’s marquee schools according to tax filings. Adding three the NCAA basketball tournament. But without having to take on the risks of more would mean having to come up the bulk of collegiate athletic funds operating the proposed 18-team league. with an additional $30 million in annual derive from ticket sales — 26 percent. In hindsight, it all makes perfect revenue to make sure incumbents Schools with 80,000- to 100,000-seat sense. The ACC’s and the Big East’s weren’t giving up anything. football stadiums, packed seven times

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a year, reap even larger shares moting stability, only seldom from ticket sales. Larger still Conference Shuffle reaching out to swipe each are alumni and booster contri- Since the summer of 2003, 19 schools have announced changes other’s schools. butions at 18 percent and direct in conference affiliations. The ACC’s plucking of three Big East University of Chicago econ- institutional support at 10 schools got the ball rolling. omist Allen Sanderson likens percent. collegiate athletic conferences Tipping the scales in favor To the ACC To the Big East to a cartel. When everybody of conference enlargement was (all from Big East) (all from C-USA) obeys the unwritten rules, a relatively new post-season Miami Cincinnati everybody profits. “But there’s feature of the NCAA — the Virginia Tech Louisville always the incentive to cheat, Bowl Championship Series. Boston College Marquette whether it’s OPEC or the The BCS was set up in 1998 DePaul NCAA,” Sanderson says. for the purpose of declaring a To the Atlantic 10 South Florida The ACC wasn’t cheating, bona fide national champi- (both from C-USA) but it was moved to take action onship in football. At the same UNC-Charlotte To Conference USA after observing several eyebrow- time, it preserved the tradi- Saint Louis Rice (from WAC) raising developments. One risk tional, and itself highly Southern Methodist (from WAC) that several ACC managers profitable, bowl game system. To the WAC Tulsa (from WAC) cited was that Miami — Six Division 1-A conferences (all from Sun Belt) Marshall (from MAC) crowned football National are guaranteed bids to the four New Mexico State Central Florida (from MAC) Champion in 2001 — would BCS games — the Orange, Utah State Texas-El Paso (from WAC) join the SEC if not courted by Rose, Sugar, and Fiesta bowls Idaho the ACC. In their worst night- — with the top two ranked SOURCE: NCAA; Conferences mares, ACC officers saw Florida teams in the country squaring State deciding to follow, thus off for the so-called national depleting the conference of its title. (A fifth BCS bowl game may be BCS — were mostly making money. foremost football draw. At the same added soon.) The ACC is one of those Thus, the key to making money in time, the opportunity to widen its TV with guaranteed bids. The payoff for a college athletics is strongly tied to con- audience from New England down to national title entry is up to $14 million. ference membership. With the the southern tip of Florida was too Even the lesser bowls are worth as much introduction of the BCS, schools had good to pass up. They wouldn’t even as $11 million. a new incentive to consider changing have to change the conference’s The conferences that get automatic allegiances. “A tlantic” name. berths are known as BCS members, Dan Fulks, an accounting profes- “It was our belief that a number of and membership has its privileges. sor at Transylvania University in changes would be coming anyway,” Non-BCS conferences get a cut of the Kentucky and an NCAA consultant, ACC Commissioner Swofford says. “If bowl game spoils, but it amounts to recalls a conversation with a BCS com- we were proactive, then we were in a between $300,000 and $800,000, or missioner about the widening gap much better position to effect change as little as $74,000 per school. By com- between “have” and “have-not” con- that would impact us positively rather parison, BCS conference schools take ferences. The commissioner replied, than having to react.” in about $2 million each in bowl game “Look, don’t blame me. My job as com- Acquiring schools from the Big East payouts. That means in any given year, missioner is to make as much money wasn’t the ACC’s only option, however. Wa ke Forest University can expect a as I can for the schools in my confer- After the BCS system was announced, big BCS payout even though it his- ence, and that’s what I’m going to do.” Big East leaders laid out their strate- torically hasn’t sent a single team to a gic options. They realized that being BCS game. Conference Rivalries Heat Up No. 6 in revenue in an 11-conference For the ACC, it was financially To be sure, conference realignments system was a precarious position. imperative to keep a seat at the table are nothing new (see sidebar). The In 1997 and 1999, the Big East at the lucrative BCS. On average in reason they happen relatively infre- approached the ACC about joining the 2002, conference schools were losing quently has to do with the “industry” two leagues’ football programs into a money on their athletic programs. structure. Think of athletic confer- single “federated football conference,” That’s in part because athletic revenues ences as rivals in an industry where the according to parties familiar with the must be spread around to fund a typical schools are the suppliers and fans and talks. The thinking was that such a school’s less visible sports, ranging from the TV broadcasters are the buyers. coalition would upgrade the confer- soccer to field hockey. But those at The conferences are mainly differen- ences’ negotiating position with TV the top of the food chain — schools tiated by their school membership. networks. Together, the Big East and in the biggest conferences, all in the They maximize their profits by pro- the ACC would command an 18-team

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football league that could deliver the ACC’s] opportunity to choose ACC schools did Swofford. entire East Coast broadcast market. between alternatives and they clearly “The way it was structured, it But the ACC was cool to the idea chose one that made them better off.” didn’t allow the commissioner to go in the 1990s. And when Big East man- out and get things done,” Sauer says. agers pitched the idea anew in the The ACC’s Competitive Advantage “It’s not that John Swofford was any summer of 2003 in an effort to fend How come the ACC was in position more capable than Tranghese up in the off the ACC’s expansion, the answer to make such a choice? A crucial Big East. It’s just that his organization again was ‘no.’ Neither Swofford nor advantage the ACC held over the Big enabled Swofford to effectively move Big East officials would comment East was organization. The ACC has in the direction that the economic about the ACC-Big East merger talks. nine member schools that participate forces dictated the football conference Analysts interviewed for this story said in all sports and distribute conference would move.” the ACC was probably turned off by revenues equally. If there’s a downside to expansion, a merger for several reasons, including By contrast, the Big East, based in it’s the deterioration of some longtime an unwillingness to adopt separate Providence, R.I., created its basketball rivalries. Every fan wants Duke to football and basketball memberships and football programs separately. come to his school at least once a year and the logistical concerns of operat- It kept nine schools for football pur- for hoops, but that’s no guarantee ing an unwieldy 18-school league. poses only and 14 for basketball. under an expanded league. Swofford, “The Big East is a cobbled together Georgetown University, for example, who played football at North Carolina conference in the first place, and their participates in Big East basketball but before rising to the league’s commis- next move is trying to cobble the ACC doesn’t field a Division 1-A football sioner office, says he understands the into their mix,” says Sauer, the team. West Virginia University, how- importance of fan sentiments in the Clemson economist. “It makes good ever, plays both. Conference revenues ACC’s culture and revenue stream. At strategic sense for them to do that but were not handed out equally, and Big the same time, “The feeling was that they’re not really taking the ACC up East members didn’t give Commis- the collective gain far outweighs the a peg with that proposal. It was [the sioner Tranghese the same leeway that things we would give up.”

Conference Came Undone

Conferences do collapse. Rewind to Big 12. The Western Athletic Conference will lose Rice, Southern Methodist, the 1996 for the final incarnation of the (WAC) swallowed three of the remaining University of Texas at El Paso, and the once-proud Southwest Conference schools, Southern Methodist University, University of Tulsa. (SWC). An 82-year-old league, marquee Rice University, and Texas Christian After all that, has the conference members included the University of University, while the University of shuffling reached its limit? “I believe that Texas, Texas A&M, and Baylor Houston hopped to the newly founded conference realignment will occur when University. Adorning member trophy Conference USA. it is economically feasible to do so,” says cases were seven national football cham- The mid- and late-1990s, then, saw Patrick Rishe, an economist at Webster pionships, five Heisman Trophies, and nearly as much conference shuffling as University in St. Louis. But even Rishe two women’s basketball titles. in 2003, bolstering the NCAA’s assertion believes it will be a while before more But talk about regional: After the that conferences have long been “adding conferences fold, expand, or otherwise University of Arkansas left in 1992 for the new members, casting off those that no realign in significant fashion. Southeastern Conference, all eight mem- longer fit and changing their geographic “I think that we’ve just about bers were from Texas. That was fine when landscapes.” Witness the near-unraveling stretched our limits. Perhaps the Big 10 cross-state rivalries provided all the rev- of the WAC in 1999, when eight schools, [which, despite its name, actually has 11 enue a conference needed to thrive, but it including four charter members, withdrew members since Penn State joined in 1993] was a huge liability at the dawn of the to found the Mountain West Conference. will add another team soon to reach the 1990s when national TV contracts The WAC soon picked up Boise State magical number of ‘12’ that’s necessary became the norm. University and Louisiana Tech University, for a football championship. And per- Texas is big, but it could deliver only giving it 11 members — until former SWC haps the Pac 10 will do the same soon,” 7 percent of the nation’s TV markets. member Texas Christian switched confer- Rishe says. “When the Pac 10 does this, it Nearing its deathbed, the SWC talked ences again, leaving for Conference USA will cause a mini-domino effect as the with the then-Big Eight about a merger. at the end of the 2000-2001 season. lesser West Coast conferences scramble Instead, four SWC schools — Texas, Idaho, New Mexico State, and Utah State to try to replace teams that shift to other Texas A&M, Texas Tech, and Baylor — have agreed to join the WAC in 2005. conferences, but nothing like what we simply up and left for the soon-to-be But, at the same time, the conference recently saw.” —DOUG CAMPBELL

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Athletic Conference Cash In 2002 the ACC was the fifth-largest “It’s not a perfect world. But did Syracuse and Connecticut, he argues NCAA conference by revenues. they improve themselves? Yes. They did that the Big East is now even more 50 in terms of financially improving them- so “the strongest basketball confer- selves and in terms of having a seat at ence in the country.” As for the Big

) 40 2002 Revenue the table in the future of any big foot- East’s participation in the BCS, Mar- 2002 Profit OFIT

R 30

P ball talks, whether that’s playoffs or an inatto believes the league’s spot is

20 expanded BCS,” Rayburn says. secure for “the foreseeable future.” The Big East wasted little time

ILLIONS OF10 DOLLARS EVENUE AND M once all the ACC pieces fell into place. What’s Next? R IN ( 0 By November 2003, it had picked up The view from the ACC today is espe- five new schools to replace the three cially bright. The league placed six -10 Big 10 SEC Big 1 Pac 10 ACC Big Moun C-USA WAC MAC Sun East Belt 2 tain West departed. But in the process, the con- teams in bowl games, but only mus- ference pegged its future on basketball tered one — new addition Virginia CONFERENCE and, according to some observers, may Tech — in the BCS. ACC men’s bas- NOTE: Figures are per-school averages. SOURCE: NCAA lose its automatic bid to the eco- ketball retains its pre-expansion cache, nomically rewarding BCS. The five with national broadcasts of pairings a new schools are Cincinnati, Louisville, commonplace. Between the new tele- The Payoff DePaul, Marquette, and the Univer- vision contracts, the possibility of an After some stumbles and lawsuits, sity of South Florida. Only the first extra BCS game and a football cham- in which at first only Miami and two of those schools have Division 1- pionship, the ACC already has topped Virginia Tech were asked to join, the A football teams, and neither is a the necessary $120 million annually to ACC completed its growth spurt in perennial standout. When all the provide all its schools more money October 2003 when Boston College league switching is done, the Big East than before expansion. signed up. With B.C. on board, the will have eight “full” members that “I think the ACC is done (expand- ACC had achieved the magic number play both football and basketball and ing) for the time being, but it’s not 12, qualifying under NCAA rules to another eight that play just basketball. clear to me what the national scene hold a conference football champion- Strategically, it may have been the will look like,” says Prof. Nemhauser, ship game. Big East’s best, and only, option. “The who started it all. The collective gain was almost Big East, realizing its status in foot- Conference realignment is a game instant. TV contracts were quickly ball took a hit; they had to ask with no clock. The BCS came under renegotiated, and even incumbent themselves a question,” says Patrick fire — again — this year for failing to ACC schools are to take in an esti- Rishe, an economist at Webster Uni- produce an undisputed national cham- mated $800,000 more annually under versity in St. Louis. “Based on the pion, as undefeated Auburn was left out newly inked deals with ABC and landscape in the short-term all we can of the title game. Additionally, there was ESPN. Also, new contracts were struck do is stay floating. So why not go evidence that the Big East’s recent depar- with Charlotte-based Jefferson Pilot ahead and become the strongest bas- tures have already weakened the Sports (JP Sports), which has top ketball conference?” conference to the point where it should distribution and broadcast rights to John Marinatto, a Big East associ- no longer get an automatic BCS bid: Big ACC basketball and regional rights to ate commissioner who was closely East champion University of Pittsburgh ACC football. (JP Sports also has involved in the expansion process, says went to the Fiesta Bowl despite its mid- rights to SEC regional football games.) the new members accomplished the dling 8-3 record. Whether the BCS Jimmy Rayburn, vice president of conference’s goal of growing TV rev- expands or shrinks membership, whether operations with JP Sports, thinks the enues. He describes Cincinnati and broadcasters recalibrate how much loss of round-robin-style matchups Louisville as significant broadcast they’re willing to pay for airing rights — in basketball will hurt but agrees markets for football. Noting that the these will be the main factors in deter- with Swofford’s overarching view that past two basketball championships mining if the conference earthquake of the conference improved itself. have been won by member schools 2003 has run out of aftershocks. RF

R EADINGS Fulks, Daniel. Revenues and Expenses, Profits and Losses of Division Roush, Chris. “More members mean more money for ACC.” 1-A Intercollegiate Athletic Programs Aggregated by Conference — Business North Carolina, Sept. 2004, pp. 30-31. 2003 Fiscal Year. Indianapolis: NCAA Publications. Visit www.rich.frb.org/pubs/regionfocus for links to relevant sites. Rosenberg, Beth. “Domino Effect: Division 1-A conference realignment has had emotional, structural impact.” NCAA News, Dec. 8, 2003.

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sinkOR SWIM Fifth District coastal ports must continue to expand to remain competitive

BY CHARLES GERENA

few autumns ago, a single Louisiana have the busiest ports, but receive government funding for capital barge sailed the Intracoastal the Fifth District is no slouch with projects. The Port of Baltimore and A Wa terway along the Carolina four major coastal facilities. Three of the Port of Virginia receive regular shore. Sitting atop the vessel, like them — the Port of Charleston, the appropriations as part of their states’ massive stallions of metal and rivets, Port of Baltimore, and the Port of transportation departments. were two cranes that traveled more Virginia in the Hampton Roads region In sum, these semi-private enter- than 160 miles from Charleston, S.C., — were among the nation’s 30 busiest prises play a pivotal role in global to Wilmington, N.C. in 2002, the latest year available for commerce. Without them, retailers This voyage signaled progress for aggregate data. Looking at foreign couldn’t sell merchandise from all over both ports. After making their grand trade alone, these ports currently rank the world at the low prices that con- entrance in Wilmington in October in the top 10 in terms of dollar value of sumers demand. Think of how public 2003, the cranes helped boost the goods, and the top 25 in metric tons airports enable the airline industry to capacity of the city’s port. One of the moved and container volume. The function by providing the shared beasts, a gantry crane that can carry Port of Wilmington is among the 25 infrastructure that carriers couldn’t up to 150 tons, replaced a 25-ton crane busiest container facilities. afford to own and operate individually. that had been in service for almost A state chartered, functionally At one time the physical limitations half a century. For Charleston’s port, independent authority controls the of ports dictated the size of cargo the sale of the older cranes was part land and facilities at each port. ships. Today, the relationship is of an effort to handle more cargo Charleston’s and Wilmington’s mar- reversed. Shippers push for bigger ves- from bigger ships. itime facilities must be financially self- sels to realize economies of scale and to New York, California, Texas, and sufficient, though they occasionally cut costs for customers. As a result, PHOTOGRAPHY: BILL MCALLEN PHOTOGRAPHY:

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public ports have boosted their capaci- overcome constraints on waterway goods and transfer them from ship to ty and capability to remain competitive. capacity, road and rail infrastructure land with ease and efficiency. From 1998 to 2002, they devoted nearly issues, or land availability problems According to Talley, cargo that $7 billion to capital improvements, or due to waterfront redevelopment, will used to take a week to unload can be about one-quarter of total investments be out of luck. “If you aren’t able to moved in less than 24 hours if it’s made over the last 75 years. meet the needs of the shipping com- stored in containers, resulting in sub- At some ports, maritime trade is munity, you run the risk of ships being stantial reductions in inventories. changing faster than they can adapt. attracted to another port,” says Container shipping also has resulted In the Fifth District, ports have been Kathleen Broadwater, deputy execu- in less theft, since boxes are sealed adding cranes, deepening and widen- tive director at the Maryland Port until they arrive at a consignee, and ing waterways, and investing in other Administration, which operates less damage to cargo in transit. improvements to keep pace. The Baltimore’s port. As competition in global trade has Port of Virginia and the Port of In the competitive world of global intensified, container shippers have Charleston appear to be in the best trade, such shifts in cargo flow are rou- strived to transport more boxes per competitive position to accommo- tine. For individual ports, however, voyage and, thus, decrease per-unit date the biggest vessels, while the lost business could translate into transportation costs. This has meant Port of Wilmington has the advan- decreased economic activity on the employing vessels that are longer, tage over its larger East Coast com- local and regional level. Fewer people wider, and deeper than ever before. petitors in terms of excess capacity. are involved in water transportation of The largest ships, called “post- But the future holds additional freight — 37,400 in 2002 versus Panamax” since they exceed the challenges for Fifth District ports to 47,400 in 1992 — but they make a dimensions of the Panama Canal expand and adapt. Those that cannot comparatively good living. For exam- locks, typically measure 1,100 feet in ple, a stevedore who loads and unloads length and 136 feet in width, draw a ships earns an estimated $16.95 an maximum of 46 feet of water, and Five Generations of Containerships hour compared to $15.03 for the aver- hold 5,000 to 8,000 TEUs. (ATEU, or The capacity of containerships has increased tenfold age blue-collar worker. The businesses “20-foot equivalent unit,” is equal to in the last 50 years, driven by demands of shippers drawn to a port, from fuel suppliers to one container measuring 20 feet long, to minimize per-unit transportation costs. Ports distribution centers, generate addi- 8 feet wide, and 8 feet deep.) That’s a have been forced to keep up. tional employment and spending. big difference from the earliest con- tainer ships that carried less than FIRST GENERATION (1956-1970) Bigger, Faster, Better 1,000 TEUs. At the same time, other Converted Cargo Vessel It takes a small army of stevedores, shippers have demanded bigger ves- Converted Tanker crane operators, and other unionized sels to transport other types of cargo, Length: 135-200 m Draft: less than 9 m TEUs: 500-800 workers to run a maritime facility — from supertankers that carry enough SECOND GENERATION (1970-1980) Baltimore’s port-related employ- oil to power a small city to bulk carri- Cellular Containership ment approaches 16,000 people. ers that transport tons of grain, coal, Length: 215 m Draft: 10 m TEUs: 1,000-2,500 Historically, these workers have and other materials. loaded bundles of cargo from ships, Talley offers one example of how THIRD GENERATION (1980-1988) separated them into smaller ship- ports have reconfigured themselves Panamax Class ments, and loaded them by hand and to service these vessels. A ship used to forklift into trucks and trains. dock at a terminal perpendicular to a “There is a lot of inefficiency finger pier. Many ports have knocked Length: 250-290 m Draft: 11-12 m TEUs: 3,000-4,000 because of the restrictions on what down those piers so that container tasks they can perform. They also ships can dock parallel to a terminal FOURTH GENERATION (1988-2000) earn higher wages,” says Wayne Talley, and be offloaded by cranes. Post Panamax an economist at Old Dominion Ports also have enlarged their University who heads the school’s waterways, built longer docks, and Length: 275-305 m Draft: 11-13 m TEUs: 4,000-5,000 International Maritime, Ports, and purchased taller cranes. For example,

FIFTH GENERATION (2000+) Logistics Management Institute. the Port of Virginia is adding eight Post Panamax Plus In order to minimize labor costs, new cranes to its main terminal in shippers have moved from break-bulk Norfolk that stand higher and reach to container shipping since the 1960s, out farther into the water than any Length: 335 m Draft: 13-14 m TEUs: 5,000-8,000 transforming a labor-intensive endeav- other crane, enabling the terminal to SOURCE: Jean-Paul Rodrigue, et al. Transport Geography on or into a more capital-intensive activ- service the next generation of contain- the Web. Hofstra University, Department of Economics & ity. Enormous cranes now scoop up er ships. More than $45 million was Geography, 2004 standardized boxes stuffed with spent on the cranes and millions more

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to strengthen wharves to support the ing goods from the West to Eastern only Fifth District facility that’s big cranes. and Midwestern markets. enough for the biggest ships of the While size matters, ports have had The last straw was a labor dispute present and the future. to work smarter too. For instance, that eventually shut down 29 West Additionally, container ships stop the Port of Charleston has been Coast ports in the fall of 2002. Asian in fewer places. “They want a port implementing a yard management shippers and producers had to reevalu- which can unload their containers system that allows for more accurate ate their distribution routes to keep very quickly. Today’s ship spends most tracking of containers. These and their freight flowing. In the process, of its time moving; in the past, a ship other operational upgrades have they found a viable alternative. Instead spent most of its time in port,” says enabled the port to handle a near of sailing directly across the Pacific Rodrigue. This could mean more busi- doubling of its cargo volume in the Ocean to West Coast ports, smaller ness for larger ports, while the smaller last 10 years without developing any ships could go around North America ones will become merely feeders. new terminals. via the Panama Canal to reach East Ports could specialize in handling With global trade accelerating in Coast ports. “Once shippers began non-containerized goods. For example, recent years, port officials anticipate that process, producers rearranged Baltimore has become the largest hub further growth in the movement of their just-in-time inventory to accom- for “roll-on/roll-off cargo” such as containerized cargo, as well as break- modate the additional time that the automobiles and farming equipment, bulk shipments, bulk commodities, cargo spent on water,” Bray says. and the vessels that carry them aren’t and other goods. Much of this In the future, it may be more com- as big as container ships. Neverthe- growth is expected to continue com- mon for larger post-Panamax ships to less, every Fifth District port will want ing from trade with Asian countries, bypass the West Coast and take the to grab its share of container shipping especially imports. long way around to the East Coast, since it accounts for 90 percent of the Officials in the Fifth District primarily by going through the Middle value of non-bulk goods transported think their facilities will continue to East via the Suez Canal and then cross- globally. That will require an accelera- attract a significant share of global ing the Atlantic Ocean. However, this tion of capital investments. cargo flow. Economic trends support will happen only if it also proves to be First, there is the task of deepening their optimism. For one thing, distri- economically viable for shippers. and widening waterways even further. bution facilities are opening closer to The East Coast has some excess Since channels are federal property, population centers on the East Coast, port capacity to handle any redirected the Army Corps of Engineers per- many of which are near ports. cargo volume, according to Hofstra forms routine dredging that clears “Within the last five years, Virginia University geographer Jean-Paul channels of silt and other debris, while has attracted a significant number Rodrigue. Most of the slack is at federal funding covers part of the cost of major distribution centers,” says smaller facilities like the Port of of enlarging channels. Ports pay the J. Robert Bray, executive director of Wilmington. remainder of that tab, plus they are the Virginia Port Authority. These “We are seeing a tremendous responsible for deepening the access centers, opened by mass retailers like amount of congestion starting to channels that lead to individual termi- Home Depot, Target, Wal-Mart and occur at competing ports north and nals and the berths where ships dock. Family Dollar, import large amounts south of us,” says Thomas Eagar, Some ports in the Fifth District of merchandise, so they have CEO of the North Carolina State are further along than other facili- “demanded increased shipping service Ports Authority. “That’s bad news for ties. The Port of Virginia and the [and] caused ships to offload much them, but good news for us. We are in Port of Baltimore currently have more cargo than they did in the past.” the midst of serious discussions with 50-foot-deep main channels, while At the same time, there has been two or three major container lines the Port of Charleston has an mounting interest in East Coast looking to divert [cargo] or bring new entrance channel measuring 47 feet ports as congestion at their West services to the Port of Wilmington.” deep and an inner harbor of 45 feet Coast counterparts has led to higher following the completion of a $150 costs and headaches for shippers Reality Check million deepening project in 2004. sending goods to and from Asia. Last But how much additional cargo vol- The Port of Wilmington also fin- October, dozens of ships reportedly ume can Fifth District ports realisti- ished dredging its navigation channel waited at the Port of Long Beach to cally capture in the near term? Even if to 42 feet last year. dock and unload consumer products more shippers utilize the wider and So what if the Charleston port’s bound for retailers stocking up for deeper Suez Canal and other longer channels are shallower than Virginia the 2004 holiday season. On top of routes to the East Coast, many of or Baltimore? “It makes a heck of a that, the price of cross-country rail their vessels wouldn’t be able to fit difference,” says Bray of the Virginia and truck transportation has been into most ports once they arrive. At Port Authority. “Some of the larger rising, adding to the expense of mov- present, the Port of Virginia is the ships that Maersk and other shippers

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have will draw a little more than 47 berths are shallower. The Port of Charleston recently dredged all of the feet of water when fully loaded.” Virginia’s Norfolk terminal has 50- berths at one terminal to 45 feet and Channels need to be at least 50 feet foot berths, but the Portsmouth and three berths at its main Columbus deep to provide a margin for error Newport News terminals have berths Street terminal to 52 feet, putting it when water levels in harbors change. that are only 45 feet deep and 42 feet ahead of its Fifth District competitors. For now, the Virginia and Baltimore deep, respectively. Bray says there In addition to making more room ports are ahead on this count. The isn’t a need to excavate at these in its waterways for container ships Charleston port’s harbor could be terminals, but another deepwater and other large vessels, ports will need deepened, but officials are holding off facility is planned across from the more dry land as operational improve- on doing it due to the cost, according Norfolk terminal at Craney Island, an ments at existing terminals prove to spokesman Byron Miller of the area created with dredge material. insufficient to deal with rising cargo South Carolina State Ports Authority. At the Port of Baltimore, an esti- volume. Land also has to be available Any dredging that goes beyond 45 feet mated 40 percent of its berths are too nearby for additional warehousing and lowers the federal share of project shallow. Some of them are being deep- distribution centers. funding to 50 percent. Instead, the ened, says Kathleen Broadwater at the Some ports have land inventoried for port will continue investing in its Maryland Port Administration, but future expansion, but it can take a while existing terminals and build a new others will have to wait until the port’s to develop it. The construction of a new span across its main shipping channel older terminals are rebuilt so that terminal for the Port of Charleston at a to accommodate taller ships. dredging to 50 feet doesn’t undermine former naval base will take up to five Perhaps Charleston shouldn’t any structures. Such rebuilding proj- years once the permit is approved. trouble itself. Having deep channels ects are pending funding from the state Moreover, the land may never be doesn’t do much good if a port’s legislature. Meanwhile, the Port of fully exploited if there are insufficient

Cruisers and Containers Containers aren’t the only things that Fifth District ports ships leave from the Port of Wilmington regularly, but they do handle. Cruise ship passengers have joined the flow of goods at stop there occasionally as they travel along the East Coast. terminals in Baltimore, Norfolk, and Charleston in the last few This volume is relatively small compared to the hundreds of years, generating new business and tourism-related dollars that cargo ships that call at ports every day, but they are still a signifi- have prompted some cities to make additional investments in cant source of revenue. “Port service providers at each of the their cruise facilities. embarkation ports and ports-of-call in the United States provide Traditionally, south Florida and New York have been the most a broad range of services, including tugboat and piloting services, popular departure points for cruisers. In 2003, their ports han- stevedores, passenger reception services, warehousing and other dled about 5.1 million of the 7.1 million passengers who set sail material handling services,” noted an August 2004 economic from the United States. But several factors have created oppor- impact study commissioned by the International Council of tunities for other ports to attract some of this passenger flow. Cruise Lines (ICCL). “During 2003, the cruise industry spent According to Brian Major, spokesman for the Cruise Lines $1.6 billion on such port services.” International Association, more ships are sailing — the worldwide Additionally, the passengers and crew on cruise ships spend fleet has grow by two-thirds in the last five years alone — and their money in nearby communities. The ICCL study found that cruise operators are looking for more options to offer to repeat about a third of cruisers stay one or more nights at a port city and customers. Both trends have fueled the need for additional depar- spend an average of $195 per visit. Those who arrive the day of the ture points. cruise dole out an average of $17 per visit while ship personnel At the same time, cruise operators have moved their home- spend $29 per visit. (As a side note, the big-spending overnight ports closer to coastal cities, explains Major. “With the reluctance passengers are smaller in number: 2.3 million compared to 4.8 mil- to travel far away and to fly, [they believed] people would appreci- lion day-of-arrival passengers and 4.4 million crew members.) ate having a ship close to a large, regional population center that is Going forward, waterway capacity for cruise ships shouldn’t within driving distance.” be a problem. Most ports can handle the largest vessels. Finally, cruise operators have more flexibility in where they However, terminal capacity could be an issue if Fifth District choose to operate. Ships are much faster, enabling them to ports continue attracting the attention of cruise operators. So, embark from ports farther away from their destination and make city officials in Norfolk plan to build a new $36 million cruise additional stops during their journeys without losing time. ship terminal to replace a temporary facility next to the Nauticus Fifth District ports have managed to attract their share of science center, while Maryland will invest $3 million to cruise ship calls. In 2003, 31 ships departed from Baltimore, $4 million to renovate a cargo terminal in Baltimore to exclu- another 31 from Norfolk, and 17 from Charleston, and all three sively serve cruise lines. Charleston already has a cruise ship ports experienced growth in departures for 2004. No cruise terminal in its downtown historic district. —CHARLES GERENA

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roads and rail lines to transport the Every Fifth District port com- additional cargo volume. Charleston’s petes for land with the private sector Where Ports Stand proposed expansion on Daniel Island to some degree. Waterfronts contain U.S. Waterborne Foreign Trade, Total was scratched partly due to concerns underutilized or abandoned industri- (Thou. of Metric Tons) about nearby road capacity, while a al property, but they also offer great Port 2003 Rank Among Top 25 proposed third bridge-tunnel system views that residents and office work- Baltimore 22,443 18 in Hampton Roads is critically impor- ers value. “The most desirable land is Norfolk 22,011 19 Charleston 17,245 22 tant for the Port of Virginia’s future always coastland, so [ports] have a lot terminal on Craney Island because it of competition with real estate devel- U.S. Waterborne Foreign Trade, Total will help relieve local traffic jams. opment,” Rodrigue says. “People pre- (Mil. of Dollars) “More and more folks want to live fer to see condos rather than a port Port 2003 Rank Among Top 25 closer to the water,” says Miller. “That’s terminal.” Charleston 39,375 5 putting additional pressure on road Port authorities have the power Norfolk* 29,486 6 Baltimore 25,956 8 infrastructure. As the [coastal] popula- of eminent domain, thanks to state tion continues to grow, perhaps even legislation, but they rarely use it. U.S. Waterborne Foreign Trade, Containerized faster than the trade grows in port Taking private property for public use Cargo cities,” governments will have to respond. usually requires lengthy court pro- (Thou. of TEUs) ceedings that often become mired in Port 2003 Rank Among Top 25 Charleston 1,250 4 Cargo Or Condos? legal disputes. Additionally, this power Norfolk* 1,093 6 Coastal development has also made it isn’t unlimited. Baltimore 307 13 difficult for ports to expand. “Most of Rather than public ports bidding Wilmington 72 25 our major commercial ports are locat- against private developers, some port NOTE: *Excludes trade at Newport News and Porsmouth terminals ed in highly developed, urban areas, advocates suggest using restrictive at the Port of Virginia and as a result face real constraints on zoning to preserve waterfront prop- SOURCE: U.S. Maritime Administration how much land is available for use as erty for future port expansions. In marine terminals,” said Christopher September, Baltimore officials creat- ate more taxes,” Rodrigue says. Koch, president of the World ed a “maritime industrial overlay dis- Instead of government arbitrating Shipping Council, in May 2001 testi- trict” that prohibits nonmaritime development, as Baltimore did, mony to a House of Representatives development along a large stretch of developers argue that buyers and sell- subcommittee. harbor for the next 10 years. ers should determine the highest and Homes and businesses surround But what if ports don’t need the best use of waterfront property. the terminals of the Port of Virginia, land and other industrial users aren’t Anyone who is willing to put their but there is still some room for projects demanding it due to consolidations money on the table should be allowed such as the planned expansion of a paper and market shifts in the manufactur- to redevelop a site, especially some- distribution facility near the Newport ing sector? The rezoned property one who wants to convert underuti- News terminal. Development is occur- would simply sit unused. lized industrial space into housing or ring along Wilmington’s waterfront, Such a scenario would probably be office space that is in demand. but mostly in the northern half where hard for local governments to swal- Regardless of how these issues older maritime facilities are being low. Since their interest is in encour- will be resolved, Fifth District ports converted into condominiums, offices, aging economic growth, they provide are acutely aware of the competition and marinas. The southern waterfront incentives like tax breaks and clean- they face. The next generation of where the port resides has remained up assistance to support waterfront larger container ships will be sailing mostly commercial. As for Baltimore redevelopment. “I have heard of hor- the oceans in coming decades, and and Charleston, residential, office, and ror stories where real estate projects will require ports to get bigger and tourism-driven retail development aimed at closing almost the entire smarter to handle the growing vol- encroach on maritime activities, making port because building condos and ume of containers, or else develop port expansion very difficult. commercial real estate would gener- other customer bases. RF

R EADINGS Notteboom, Theo E. “Container Shipping and Ports: An Overview.” Ta l ley, Wayne K. “Ocean Container Shipping: Impacts of a Review of Network Economics, June 2004, vol. 3, no. 2, pp. 86-106. Technological Improvement.” Journal of Economic Issues, Rodrigue, Jean-Paul. “Transport Geography on the Web.” December 2000, vol. 34, no. 4, pp. 933-948. Web site hosted by Hofstra University, Department of Economics Trade and Transportation: A Study of North American Port and Intermodal and Geography. Systems. Washington, D.C.: U.S. Chamber of Commerce, March 2003. Visit www.rich.frb.org/pubs/regionfocus for links to relevant sites and supplemental information.

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shameAND BANKRUPTCY The number of Americans filing for bankruptcy protection has surged fivefold in two decades. A Richmond Fed economist challenges the conventional wisdom that declining stigma is at the root of the increase

BY DOUG CAMPBELL

“At one time in our history, he narrative sounds convinc- How else to explain skyrocketing ing: Crazed consumers, their bankruptcy rates? Consider the case of filing bankruptcy was regarded as T wallets stuffed with maxed- the 1990s. Personal bankruptcy filings shameful, and filers suffered social stigma out credit cards, rack up unseemly surged 35 percent to more than 1.4 mil- sums of debt and then shamelessly lion a year in 1997 from 924,000 in and permanently ruined credit. The shame unload it all in bankruptcy court. 1991. The median total of unsecured Back in the good ol’ days — say, the debt borrowers discharged in bank- and stigma are no longer compelling.” 1920s, 1950s or even 1980s — this ruptcy in 1981 was $12,452. By 1997, it — The Hon. Edith Jones, never would have happened, the con- had soared more than 50 percent to former member of the National Bankruptcy ventional wisdom goes. Americans $19,515. The pace of filings was eight Review Commission, had integrity. They certainly wouldn’t times higher than population growth. March 1999 bail themselves out by the million (Business bankruptcies account for with bankruptcy protection. Their less than 3 percent of total filings.) reputations were too important. That That unemployment was low, the was then. Nowadays, with bankruptcy stock market rising, and the economy “Stigma is by no means dead.” increasingly commonplace, the stigma generally humming as bankruptcy fil- — Kartik Athreya, economist, has faded. It’s an embarrassment of ings accelerated left analysts reaching Federal Reserve Bank of Richmond, 2004 riches in reverse. for answers. The stigma rationalization PHOTOGRAPHY: COMSTOCK IMAGES COMSTOCK PHOTOGRAPHY:

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was as expedient as it was convenient. University of Mary Washington and It squared with the gut feeling Mary Eschelbach Hansen of Consumer Filings of many Americans that moral stan- American University note in a recent The steep climb in U.S. consumer bankruptcy dards were falling. Credit cards had paper that worries about declines in filings (which also happened in the Fifth District) indeed become widely available, but stigma were shared by credit experts during the 1980s and 1990s led many to believe why were so many people using their in the 1920s. The difference in the that people no longer felt shame in seeking court plastic with reckless abandon? 1990s was the seemingly persuasive protection from paying their debts. A Richmond The trend continued into this combination of shame and fast- Fed economist attributes the rise to cheaper lend- century. In 2003, more than 1.6 increasing bankruptcy cases. The ing costs incurred by creditors.

million people filed for bankruptcy bankruptcy-and-shame theory offi- 1.8 protection. By comparison, in 1983 cially entered the zeitgeist. 1.6 only 286,444 Americans went bank- Intangibles like stigma aren’t usual- 1.4

rupt. About seven out of 10 debtors ly fodder for number-crunchers. But it ) file under Chapter 7 bankruptcy wasn’t long before economists began 1.2

protection, in which all their unse- weighing in, albeit at first indirectly. 1.0 IN MILLIONS

( Fifth cured debts are erased. Chapter 7 fil- David Gross of Lexecon Inc. and District 0.8 U.S. Total

ings account for $36.4 billion of the Nicholas Souleles of the University of ILINGS F total $40 billion discharged each year Pennsylvania seized on a “demand- 0.6 OOF

in bankruptcy. Most of the rest comes effect” explanation for escalating N 0.4 in the form of Chapter 13 bankrupt- bankruptcy. People have become 0.2 cies, in which payments for secured more willing to default over time in 0 1981 1983 1985 1987 1989 19 19 19 19 19 20 20 debts are rescheduled but still result in part because the costs of default, in- 9 9 9 9 9 0 0 1 3 5 7 9 1 3 the discharge of most unsecured debt. cluding nonmonetary costs like social YEAR stigma, have declined. Our work “is SOURCE: Administrative Office of the U.S. Courts The Conventional Wisdom suggestive of a decline in social stigma The “declining stigma is the root of or information costs, but it is not con- bankruptcy” way of thinking has clusive,” they wrote in an article pub- when they lived in a district that had gained currency. The winter 1999 issue lished in the spring 2002 issue of the a higher filing rate relative to popula- of Harvard Magazine chimed in with Review of Financial Studies. tion. They argued that people are a typical hand-wringing account: Economists Michelle White of the more likely to learn about bankruptcy “Credit industry analysts hold that the University of California at San Diego, from friends and family and to decide stigma of bankruptcy has traditionally Erik Hurst of the University of that bankruptcy is, by extension, kept people honest about their ability Chicago, and Scott Fay of the socially acceptable if they live in a to pay debts. Earlier generations of University of Florida took that case to district with a higher filing rate. In an debtors lashed themselves to austerity another level. White has long held that interview, White elaborates: “You get budgets, sold off possessions, and — shame aside — we should expect a subliminal message that it’s not worked extra shifts to avoid the shame more people to file for bankruptcy stigmatized.” of defaulting. But today, says the because it is financially advantageous So the issue seems largely settled: industry, many debtors have chosen to to do so. By her tally about 15 percent Bankruptcy is being accelerated by see bankruptcy as a convenient loop- of U.S. households could gain from declining stigma. Well, not so fast. The hole against collections.” bankruptcy protection but less than 10 debate over stigma’s role in bankruptcy Towson University economist percent of those same households — is very much alive, and the implications Joseph Pomykala, in a 1999 article, and only a tiny fraction of all U.S. for how it’s resolved are important. offered up a virtual bankruptcy hall of households — actually do. In their shame: a doctor who filed for bank- widely cited 2002 American Economic The Challenge ruptcy immediately after charging a Review article, “The Household Steering stigma-and-bankruptcy re- $60,000 European vacation on his Bankruptcy Decision,” White, Fay and search in a new direction is Kartik American Express card; a waiter who Hurst backed the “strategic model” of Athreya, an economist with the Federal accumulated $170,500 in debt over bankruptcy, which predicts that peo- Reserve Bank of Richmond. His work just six months for items including a ple file for protection not so much leads him to conclude that it’s “shame gambling trip to Atlantic City. because of adverse events but because as it ever was,” to borrow from the title Funny thing is, this is old news. they see financial benefit. of one of his recent papers. For decades, preachers, politicians, White’s team took a stab at Athreya says that bankruptcy rates and ethicists of all stripes have railed testing the bankruptcy-stigma theory. are climbing because it’s much cheaper about the decay of fiscal virtue. Basically, they found that people were for creditors to make loans. As a result, Economists Bradley Hansen of the more likely to file for bankruptcy riskier borrowers are eligible to accu-

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says. “It’s got this really a type of insurance against certain long history as an insur- outcomes. It makes them willing to ance product, broadly borrow to tide over bad times. But if speaking, but the ques- bad times persist, we give them an out tion that is of interest to through bankruptcy.” economists is: Is this Until recently, Athreya’s research insurance product worth had concentrated on the conse- having around?” quences of expanded unsecured credit Bankruptcy is of inter- combined with lax bankruptcy law. est to economists because (He decided that it was a bad it’s supposed to be a safe- combination, helping a small number ty net against all the of poor people at the expense of other hazards of modern-day people in a manner that reduced over- life, from divorce to dis- all welfare.) Additionally, he is looking ability, and the conse- into the interplay between U.S. social quences of maintaining insurance programs like unemploy- this safety net are not to ment insurance and bankruptcy. be taken lightly. Credit The trick with stigma was figuring costs are higher for every- a way to plug it into a mathematical Mounting consumer debt spawned big increases in body because borrowers model. Given that shame isn’t an bankruptcy rates during the 1990s. A Richmond Fed always have the option to seek the observable statistic, like the unem- economist suggests that widely available credit — sanctuary of bankruptcy court. To ployment rate or the gross domestic more so than falling stigma — was the driver behind hedge their bets, lenders charge more. product, it’s quite a neat trick. the gains. In theory, economists say that in Here’s how he did it. First, he looked mulate levels of debt that in previous a world where shocks to people’s at some facts and found that from 1991 decades would have been unheard of. income are “transitory” — that is, tem- to 1997 bankruptcy rates roughly dou- “If stigma really went down, it’s hard porary, surmountable setbacks like bled. Next, he took the following actual for me to understand creditors making unemployment or brief illnesses — data from 1991: bankruptcy filings, the loans on the favorable terms they’ve then it’s hard to justify a role for bank- median level of debt discharged in been making them,” Athreya says. ruptcy. In such a world, the costs of bankruptcy, and credit card charge-off “Declining stigma should have some bankruptcy — making borrowing more rates. He then constructed a model impact on the cost of credit.” expensive for everybody — outweigh designed to capture important factors Athreya is a relative newcomer the benefits an average person might influencing bankruptcy — including to the shame-and-bankruptcy fray. obtain from being able to walk away stigma — that approximately matched Stumped for a dissertation topic in from his debts. But those same econo- the 1991 data. Finally, he lowered the 1997 he took a year off from his gradu- mists concur that if income shocks cost of stigma in the model to see what ate studies at the University of Iowa to are more severe and permanent, bank- effects that produced. work for Citibank’s credit card unit. ruptcy makes economic sense. And we When Athreya lowered the cost of One of his jobs was to figure see such shocks all the time: workers stigma — as was supposedly happen- out how much default the company lose limbs in plant accidents; jobless ing in America during the 1990s — he should view as a simple cost of doing mothers divorce and are awarded sole came up with a bankruptcy rate of 0.18 business, and how much ought to be custody of their children. The ability percent in 1997, a close approximation either recovered or prevented from of those people to dig their way out of to the actual 0.2 percent rate. But the happening in the first place by not debt is forever blunted, and so bank- model yielded results that were way extending credit to risky consumers. ruptcy protection is the best answer. off in terms of the level of debt held Athreya headed back to campus the On top of all this is the potential by Americans. In Athreya’s lowered- next fall with a fresh focus. Citibank role of bankruptcy in fostering stigma model, the median debt-to- had a specific business problem. What America’s entrepreneurial culture. income ratio came out as 0.85 percent. intrigued him was the wider role that Innovators must take risks, both In reality, it was 50 percent. Why the bankruptcy played as an American financially and otherwise, and offering difference? In the model, when stigma institution. Was bankruptcy good for the option of bankruptcy court is falls and bankruptcy rates rise, lending the country? viewed as an important part of culti- becomes riskier. So lenders require a “Bankruptcy has always been vating entrepreneurship. higher return to compensate for the talked about in terms of providing a The Richmond Fed’s Athreya puts increased risk. Facing higher interest kind of insurance or backstop against it this way: “We agree that bankruptcy rates, consumers become less willing misfortune for honest people,” Athreya in principle can provide people with to take on debt. PHOTOGRAPHY: DON FARRALL/GETTYIMAGES PHOTOGRAPHY:

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Then Athreya found a better fit. one. White, for one, isn’t so sure that ceptual problems. But macroecono- He ran the same exercise but kept stig- stigma is dead. “I’m not a simulation mists in particular consider the econo- ma constant and cranked down the cost person. I’m not a fan of that approach my a miserable natural experiment. of lending money. Suddenly, actual and particularly,” she says, referring to How can you possibly conduct a projected figures started matching. Athreya’s model. “natural” experiment in which some The projected bankruptcy rate was “Stigma is still something we don’t 10,000 values are fixed but one small 0.19 percent (compared with the actual have any direct information about,” variable is changed? That’s what simu- 0.2 percent) and the median debt-to- White says. “It’s hard to test very rig- lation tries to get around. income ratio among filers was 40.3 per- orously. There’s a limit to what econo- Athreya agrees that economic cent (compared to the actual 50 percent). mists can do.” inquiries have their limits, but he Athreya’s interpretation of these Within those limits, however, remains satisfied with his research. results is that in the first run, where White tends to employ regression He thinks it is the closest economists stigma is lowered, “it becomes very models — and therein lies her chief have come to identifying a value for expensive to get a loan in this era.” By reservation about Athreya’s research, stigma. And it advances the debate contrast, when stigma is held constant which relies on simulation models. about what should be done, if any- and the cost of issuing loans is reduced, It’s an ongoing debate among aca- thing, to reform U.S. bankruptcy the numbers start falling in place. “It’s demics, and it is impossible to say policy. There may be no need, after cheaper for creditors to figure out who with any authority which side is right. all, for the breast-pounding over they’re lending to and to figure out In a nutshell, regression models America’s declining moral standards. information about their ongoing use historical, empirical data in which “It’s hard to figure out what shame relationships,” Athreya says. “This nar- households react the same way to looks like. That is what’s allowed this rative fits together with a lot more facts market forces. By contrast, simula- story to exist for a long time. It float- that are observable than the stigma tion models recalibrate household ed in the ether and was hard to pin story does.” reactions to new market realities. For down,” he says. “To kill stories like It also fits with other economic example: In football, historical data that you need stories for which every- research. In a recent paper, economist might indicate that lining up in “shot- thing is observable that fit the facts.” Wendy Edelberg of the Federal Reserve gun” formation would be a good idea Of course, the facts remain much in Board documented the increase of high- all of the time, because in cases when debate. Athreya, for example, con- risk borrowers taken on by creditors in shotgun has been used in the past the cedes the distinct possibility that the 1990s. Edelberg argued that tech- quarterback is seldom sacked. But in both declining stigma and declining nology-savvy creditors were able to in reality, defenses would adjust to transaction costs are at play in bank- effect partition high-risk debtors from offenses that always used shotgun ruptcy rates. “I can buy that,” he says. low-risk debtors by pricing them differ- formation, thus rendering the initial “But then the task is, how big is the ently. In the end, this had the effect of model’s results pointless. stigma? A small part? A big part?” “democratizing“ credit, or lowering the In favor of the regression approach It takes a model to beat a model, cost of borrowing for a large population. are unassailable data: Every value Athreya says, and he has yet to see a plugged into a regression model is model that discredits his. But he adds, Methodological Questions drawn from observable records. As “My model is certainly not the last Athreya’s research has turned a lot of such, regression is widely believed to word on this.” The only shame would heads, but it hasn’t convinced every- be the best tool in evaluating big, con- be in letting the inquiry drop. RF

R EADINGS Athreya, Kartik. “Shame As It Ever Was: Stigma and Gross, David B., and Nicholas S. Souleles. “An Empirical Analysis Personal Bankruptcy.” Federal Reserve Bank of Richmond of Personal Bankruptcy and Delinquency.” Review of Financial Economic Quarterly, Spring 2004, vol. 90, no. 2, pp. 1-19. Studies, Spring 2002, vol. 15, no. 1, pp. 319-347. Athreya, Kartik. “The Growth of Unsecured Credit: Hansen, Bradley A., and Mary Eschelbach Hansen. “The Are We Better Off?” Federal Reserve Bank of Richmond Transformation of Bankruptcy in the United States, 1899-1970. Economic Quarterly, Summer 2001, vol. 87, no. 3, pp. 11-33. Paper presented at a conference on the “Political Economy of Financial Markets,” Princeton University, September 26, 2003. Edelberg, Wendy. “Risk-Based Pricing of Interest Rates in Household Loan Markets.” Federal Reserve Board Finance and Pomykala, Joseph. “Bankruptcy Laws: The Need for Reform.” Economics Discussion Series Paper 2003-62, December 2003. USAToday, Nov. 1999. Fay, Scott, Erik Hurst, and Michelle J. White. “The Household Visit www.rich.frb.org/pubs/regionfocus for links to relevant sites. Bankruptcy Decision.” American Economic Review, June 2002, vol. 92, no. 3, pp. 706-718.

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Cotton fields are giving way to development as commercial and residential communities pop up along Interstate 95 in Roanoke Rapids and Halifax County. HARD TIMES North Carolina’s he Roanoke River helped Like much of the rural South, channel colonial trade from the North Carolina’s poorest counties, par- Northeast Counties T coast to the interior of north- ticularly the northeast cluster of eastern North Carolina. It helped Bertie, Halifax, Hertford, and Are Among the Poorest power textile manufacturing in the last Northampton, remain an economic century. Today, the river reels in more desert when it comes to jobs, especially in the Nation. than $3 million a year when fishermen the technology-based work that has hit Roanoke Rapids, N.C., looking for fueled economic progress in bigger Can They Reverse Course? the rockfish that spawn in mid-March. cities. Single mothers of four make do But Interstate 95 is the vein of com- on $25,000 a year; others take jobs at BY BETTY JOYCE NASH merce that’s turning the economic tide multiple fast-food restaurants. Per- today. It crosses the river and flows capita income is at 72 percent of the through the agricultural fields, leaving state average and 65 percent of the a swath of retail in its wake. Along national average. And 24 percent of the highway’s edge in Roanoke Rapids, Halifax County people are poor, com- new development has cropped up on pared to 12 percent statewide. The last year’s furrows, including a Wal- federal poverty level is $18,660 for a Mart, chain restaurants, a cinema family of four. complex. Even a Starbucks is under These distressed counties lie too far construction. from North Carolina’s coast to win big PHOTOGRAPHY: BETTY JOYCE NASH BETTY JOYCE PHOTOGRAPHY:

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from the coastal construction and recent influx of retail jobs, economists tourism boom. They are isolated from say, is better than none. Service jobs — Northeast by the Numbers the diverse job mix in cities like Raleigh, including retail — have replaced agri- Many of the counties in northeast North Carolina have some 70 miles away. Poverty hides culture and manufacturing jobs per-capita income figures well below and poverty rates among the dilapidated barns and bushes throughout rural America. More than well above the state and national averages. and among decaying mill villages. 93 percent of new full- and part-time Rural residents face few job options, jobs in nonmetro areas between 1990 and the counties suffer from high illiter- and 1999 were generated by service tend to have lower-paying jobs because acy rates as the river of human capital industries, according to the Southern of a lack of education.” rushes away from farms, fields, and former Rural Development Center. But who’s InRoanoke Roanoke Rapids Rapids, as in many rural manufacturing plants into urban areas. complaining? Halifax County is down regions,Bertie CountymanufacturingHalifax County was king. The Hertford County Northampton County to a 9 percent unemployment rate at Job Country the end of 2003, compared to a high County Per-Capita Income Share of Population Roanoke Rapids City Manager Rick of 12 percent unemployed in 2002. Below Poverty Level Benton drives along a new stretch of “We’ve gained more jobs than we Bertie $14,096 23.5% road where harvested cotton fields lie lost, but a lot are retail and not as high Halifax $13,810 23.9% adjacent to newly graded expanses of paying with good benefits as industry Hertford $15,641 18.3% earth. He exchanges greetings with the jobs,” Benton says. “We feel like now Northampton $15,413 21.3% proprietor of Twin County Powersports, we’ve positioned ourselves with invest- North Carolina $20,307 12.3% set to open any day. In the distance is ments and infrastructure with PCB United States $21,587 12.4% the Halifax Regional Medical Center, coming. They will create a world of NOTE: Data presented are from 1999. which employs 700 and serves about opportunity.” SOURCE: U.S. Census Bureau five counties. Benton explains that the The coming of commerce also new development in these fields prob- includes other venues such as a Lowe’s textile industry employed 4,000 people ably will be medical offices. A residential distribution center in neighboring at one time. But in 2002, the county’s community is also planned. Northampton County and Nucor Steel unemployment rate reached 12 percent The city and county have invested in Hertford County. And Halifax compared to 6.7 percent statewide as in water, sewer and roads along the County recently gained a company that the mill’s operations dwindled, then intersection of Interstate 95 and U.S. makes blinds, as well as PCB. Over the ceased altogether in 2003. And the Highway 158 over the past seven years, next decade, PCB plans to employ at jobless bring unpleasant realities: Almost even before the textile employers van- least 500 people in jobs averaging 11,000 people — 19 percent — receive ished. They’re building a new airport, $26,000 a year with benefits. Officials food stamps. largely with federal funds. The city has hope PCB will complement a As local economic development an award-winning program to demol- public/private investment, the North efforts concentrate on luring jobs, it’s ish or renovate homes in the mill Carolina Advanced Vehicle Research important to identify who actually village to increase tax base and reduce Center, slated for neighboring gets the jobs, according to Renkow. crime. They also developed an indus- Northampton County. But PCB aims to It turns out that it’s not always local trial site with a “shell” building, as start with only 30 local people, so it people. Renkow has studied labor economic developers do these days, will take a while for the multiplier market adjustment to employment to show business they mean business. effects to build. opportunities in the state and found The work is paying off. Retail is Job creation is the mantra for dis- that the previously unemployed take popping; the shell building will be tressed rural communities where drastic fewer than 2 percent of new jobs in a deeded to PCB Piezotronics, a sensor declines in agriculture and textiles have county. manufacturer which has pledged to left many an unskilled 50-year-old Many new jobs in rural counties are come to town, if the firm meets jobless and many a local government filled by residents who formerly com- investment commitments. And Benton with insufficient tax base. And a bleak muted elsewhere, approximately 37 spells out the significance of the employment picture motivates the most percent. New in-commuters take 32 stores, restaurants, and movies to rural valuable asset — educated people — percent of the jobs and new residents residents. to leave if they can. fill nearly 29 percent, according to “Before, if you wanted to shop, eat, “With jobs, the more money that Renkow’s findings. and go to a movie, you had to drive to flows in, the better off you are, all other Such worker mobility means that Rocky Mount,” he says. Rocky Mount things equal,” says Mitch Renkow, an workers in one county will benefit from is some 30 miles away. economist at North Carolina State Uni- the success of another nearby county, Shopping, eating, and movies, versity. “If you have a lot of people who another reason why it’s critical for coun- though, are only useful for people with are highly educated, you’ll have a higher ties to cooperate when recruiting. extra money and the jobs to earn it. The number of [better paid] jobs. [You’ll] “Rural counties have a little leg up,

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having those jobs stay at home,” he formal schooling. People worked cheap director for economic development at says. By contrast, in metro counties and lived well and had little incentive East Carolina University. new in-commuters take a whopping 51 to educate themselves. And they’re “Mill jobs were either second jobs, percent of new jobs. paying for it now. or people who worked on the family Today’s pitch for the good jobs farm found employment there,” he includes education and training. But it The Learning Curve says. “It didn’t take a lot of education wasn’t always so. In the early days of When Northern industries moved to do it. Those jobs have left and [jobs industrial recruiting, companies flocked south, it was because of cheap labor, in] farming are fewer and fewer.” The to rural areas where workers had little notes Richard Brockett, associate remaining population is trapped. Like Freida James, who is folding her Foundation Fosters Entrepreneurship in Rural North Carolina laundry at the laundromat on U.S. Highway 158. James has a steady job at Phillip Horne grew up in Northampton ners in a small firm that salvages heart one of the area’s prisons. But she hasn’t County, and his parents still live on the pine from old tobacco barns and factories gotten a raise in four years and she family peanut farm. to restore for contemporary projects. supports four children ages 4 to 11 and “I will never forget the day my father The business, Our Heritage Preserved, herself on about $25,000. She doesn’t sat me down and said, ‘I am sending you was recently featured on an NBC News want to leave the area because her away to go to school so you will not have segment. parents live there and she reasons that to do this,’” he recalls his father’s words Thinking big and small at the same even if wages are higher elsewhere, so 30 years ago. time seems to be FoR ENC’s specialty. will the cost of living be. She has friends “He probably knew in his heart of Perhaps one of FoR ENC’s most ambi- who are unemployed and friends who hearts that I would be a lousy farmer,” tious and visible projects slated for east- work at fast-food restaurants. Horne quips. “I had no idea until I left ern North Carolina is the Fund for New “I know one girl working at Wendy’s the farm and went away to an urban set- Urbanism, Sandy Point, a project and KFC both,” she comments. ting to go to college how impoverished planned by the world-renowned archi- North Carolina’s community col- my region was.” tectural firm Duany Plater-Zyberk. The leges receive state funds to train Today, Horne is president of the firm, according to Frank Dooley of FoR workers for new and expanding indus- Foundation of Renewal for Eastern ENC, was casting about for a location tries. However, state incentives have North Carolina (FoR ENC). The group, outside of Florida and a friend intro- not guided industry to distressed coun- bankrolled by private investors who back duced the group to one of the princi- ties. According to a recent report by business in exchange for equity, began pals. The model community for vision- the North Carolina Budget and Tax two years ago to stimulate the culture ary regional land planning will sit on Center, urban counties have been the of entrepreneurship in eastern North nearly 1,000 acres adjacent to biggest beneficiaries of state incen- Carolina. The group’s board is co- Albemarle Sound, three miles from tives. Sensor manufacturer PCB was chaired by Kel Landis, former chief Edenton. FoR ENC plans, with part- brought in through sizable state and executive of RBC Centura Bank, and ners, to create an Institute for Eastern local incentives. Phil Carlton, a former N.C. Supreme North Carolina on-site. For example, Halifax County has Court justice and one of the people who It’s a natural for the area, says Horne: agreed to upfit the shell building at $1.5 helped broker negotiations with the “Sandy Point is a model for what Eastern million, and the city, along with a busi- tobacco industry. North Carolina already is … we are a series ness nonprofit, will contribute The mission is to grow intellectual of inner banks towns. All were originally $90,000 to help relocate families. And capital as well as to attract money to planned along a traditional neighborhood the state offered a Job Development transform vision into reality. The group grid.” New Urbanism seeks to recreate a Investment Grant worth $1.6 million began with about half a million dollars sense of community, with shops and over 10 years in the form of annual and currently has a net worth of about workplaces and homes within walking grants equal to 65 percent rebates on $1.8 million, Horne says. “We feel we’ve distance. “It’s already been proven the state income taxes paid by workers in done a lot with a little.” creative class is dying for towns like this,” the new jobs, if the company meets Venture investments include Wave- Horne says. “What we’re trying to say is performance targets. length Broadband, which is entering its we have the raw materials … we can create This is more than Southern hospi- second round of investments and new microeconomic systems that accom- tality — it’s a sign that these are the Edenton, N.C.’s, Broad Street Software modate knowledge workers.” kinds of jobs rural areas need, but have Group, which hopes to go public within Only two years old, Frank Dooley says been hard to attract. the next 18 months. Such investments, FoR ENC is just getting warmed up. “One of the most important prob- Horne hopes, will stimulate clusters of “We can rock and roll like the Triangle.” lems…is that the kind of firms that pay knowledge businesses. They’re also part- —BETTY JOYCE NASH good wages want a quality level in their work force that may not be available

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in Halifax or Northampton coun- rural areas. On average, a 5 percent ties,” says Renkow. “You have this increase in adults with some college brain drain phenomenon, where the resulted in 4,684 new jobs in metro smart kids go to the cities. First of areas and 150 new jobs in nonmetro all, if you’re a smart kid in Halifax counties, the authors found. County, you’re going to go some- While those are modest gains, where else to go to college. And 150 new jobs in a county where then you’re going to stay there.” unemployment is high are welcome, It’s a chicken-and-egg problem, especially if those jobs come with says Mike Luger, director of the benefits and the chance of upward office of economic development mobility. at the Kenan-Flagler Business The people in Roanoke Rapids School of the University of North and Halifax County who have Carolina at Chapel Hill. worked to improve the economic “For a healthy economy, the climate believe they’re finally key elements are that the jobs Mayor Drewery Beale (right) and City Manager ahead. Losing a turf mentality being produced are appropriate Rick Benton of Roanoke Rapids stand alongside a trail helped, but it wasn’t easy. that runs for eight miles adjacent to the old canal bed for the labor force today, and lead “Regionalism has a tough time that once brought trade inland. to opportunities for higher skill taking hold in areas that don’t value in the future,” Luger says. Roanoke Rapids, it drew 1,600 people. have a whole lot going for them,” There’s the rub. In Halifax County, The lucky few who will be hired will Brockett says. roughly 35 percent of people 25 or older undergo months of training for the But tourism director Lori Medlin, haven’t finished high school, says Lyndal microscopic assembly work. who returned to her native Roanoke Williams, dean of continuing education Enhanced education is linked to Rapids to marry and raise her family at Halifax Community College. Only 11 economic growth. Although economic after 10 years in New York City, says percent hold at least a bachelor’s degree, development returns to education are she’s earned a place at the economic about half the state average of 22.5 greater in metro than nonmetro areas, development table. “That wasn’t the percent. Average Scholastic Aptitude Test an educated labor force is essential to way it was when I first came here in scores are the worst in the state: Students a healthy economy in rural areas, too, 1995.” And it’s because tourists spent scored 782, compared to the state average economists have found. $57 million in Halifax County in 2003, of 1,001. The idea is that higher levels of a 35 percent increase since she arrived And there’s no telling how many human capital attract new business, that year. Visitors include eco-tourists people can’t read. No good data are enable existing local firms to pivot who kayak or bird watch at the world- available, says Williams. She’s been when technology and conditions renowned sanctuary in Scotland Neck, involved with retraining textile workers. change, and promote entrepreneurial hunters and fishermen, and history “Their benefits are now playing out, so activity, according to economists buffs interested in the Halifax they are going to be trying to get into David Barkley and Mark Henry at Resolves, the first action by a colony another labor market,” she says. For Clemson University. urging independence. example, a class called environmental An educated labor force also stimu- In rural areas, it’s unlikely that a services trains people to wax and buff lates networking and the spread of ideas, big fish will come along and pull floors for businesses. At least one critical to the success of cluster devel- everyone out of the ditch. So it makes student started his own floor service opment. The authors found that an sense to encourage even a minuscule business, she says. increase in the number of adults with piece of the economy. People in the community are some college was associated with more “When you make a ripple in a small hungry for jobs. When PCB Piezotron- rapid employment and per-capita pond,” Brockett says, “it can make a ics held its first job fair last fall in income growth rates for urban and difference.” RF

R EADINGS Barkley, David L., and Mark S. Henry. “Does Human Capital Affect Renkow, Mitch. “Employment Growth, Worker Mobility, and Rural Rural Economic Growth? Evidence from the South.” Research Economic Development.” American Journal of Agricultural Economics, Report, Regional Economic Development Research Laboratory, May 2003, vol. 85, no. 2, pp. 504-514. Clemson University, March 2004. Renkow, Mitch, and Dale M. Hoover. “Commuting, Migration, and Brockett, Richard, Albert A. Delia, and Malcolm T. Simpson. Rural-Urban Population Dynamics.” Journal of Regional Science, “Northeast by West: An Economic Contrast of North Carolina May 2000, vol. 40, no. 2, pp. 261-287. Northeastern and Western Regions.” Research Report, Regional Visit www.rich.frb.org/pubs/regionfocus for links to relevant sites. Development Institute, East Carolina University, September 2000.

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Horses are used more for pleasure than business, but they still have a place in Fifth District agriculture

Happy trails BY CHARLES GERENA

ate July in Leesburg, Va., is fairly than a third of them are used commer- Horse Of A Different Color hot for outdoor activities, but the cially. The remaining 4.9 million are for Horses started out as work animals. L annual Summer Dressage Classic personal recreation and showing. At their peak numbers in 1915, 21 is in full swing at the Morven Park Inter- Ever since automation reduced the million horses and mules plowed fields, national Equestrian Center. One rider number of farm animals necessary for hauled people and goods, and per- outfitted in classic equestrian gear — manual labor, the satisfaction that formed other tasks. black boots, white breeches, black jacket, people get from their equine companions In the Fifth District, plantations and show helmet — circles the outdoor has provided a new foundation for the began relying on horses and mules arena on her horse. A woman stands with horse industry. “Driving through the during the 19th century as farming a clipboard and calls out different woods on a horse on a crisp fall day, shifted from using human power to maneuvers for the rider to perform. In there is nothing like it,” says Mary animal power and labor-saving devices an adjacent arena, spectators stay cool Ellen Tobias, an equine marketing like steel plows. In fact, many planta- under a tent while they watch another specialist for the South Carolina tions continued using horses for horse and rider work in unison. Department of Agriculture and a horse harvesting and transportation well into Kentucky may be called the “horse lover since the age of 3. “Once it gets the 20th century, as mechanization capital of the world,” but the horse in your blood, it’s a love that you can’t progressed slowly in Southern agricul- industry has left its hoof prints in Lees- imagine.” ture. The region’s fertile soil enabled burg, other parts of Northern Virginia, In fact, the recreational uses of horses farmers to provide pastures and grow and elsewhere in the Fifth District. have helped their numbers rebound and hay, straw, and grains for their equines. Conservative estimates from the U.S. grow. New businesses have formed Agriculture continued to change as Department of Agriculture put the dis- around these uses, generating millions of the 20th century progressed, and trict’s equine population at 244,000. dollars in expenditures on feed, fencing, so did the horse industry. “With the That number includes only animals on and other goods and services. Accord- advent of motorized vehicles and mech- farms, not those living at racetrack ing to the most recent statewide surveys, anized farm equipment, [the number stables or in horse lovers’ backyards. purchases by the horse industry totaled of equines nationwide] plummeted While horses remain part of agricul- $335 million for North Carolina in 1996; to about 2 million by mid-century,” ture, they are no longer merely inputs $505 million for Virginia in 2001; $766 remarked the authors of a 2001 study of farm production. The American Horse million for Maryland in 2002; and $104 on the horse industry in Montgomery Council says there are 6.9 million equines million for West Virginia in 2003. (South County, Md. “However, the number of in the United States, based on an impact Carolina is in the process of compiling horses soon began to creep back up. study it commissioned in 1996, but less its first equine survey.) The difference was that their primary PHOTOGRAPHY COURTESY OF MCLENDON HILLS COURTESY PHOTOGRAPHY

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role had changed from beast of burden ties. Other businesses also have emerged mare has to be fed, housed, and trained to pleasure mounts.” to provide goods and services. on a farm until she gives birth to a foal. Today, people enjoy their horses in The recreational use of horses has Then, the foal has to be raised for more a variety of ways, from the formality of not only generated new economic activ- than a year before it can be sold. Breed- equestrian shows to the thrill of a ity within agriculture, but also has ers who sell the reproductive services steeplechase. As animal sciences pro- helped traditional farming by providing of their stallions also spend money to fessor Thomas Hartsock puts it, they alternative sources of demand for crops raise their “products.” Also, those without occupy the “fun” niche of agriculture used for food and bedding in stables. a breeding facility have to rent one in that exists alongside the traditional James Steele, chairman of the Maryland order to have a controlled environment “food and fiber” activities of farming. Horse Industry Board, notes that when for equine coupling to take place. Hartsock, director of the Institute of grain prices fall, many farmers switch In addition to the activities of horse Applied Agriculture at the University to growing hay and straw for horses. owners and breeders, there are the of Maryland-College Park, puts the Local farmers typically supply horse spectators who attend equestrian com- horse industry in the same recreational owners with agricultural goods, but petitions. In Maryland, for example, category as horticulture. these crops can come from anywhere thoroughbred and harness races drew One of the most popular activities in the country. Northern Virginians 2.4 million people in 2002 compared for horse lovers in the Fifth District is have been importing hay from as far to 2.7 million who attended home games dressage. At events such as the one held away as Canada because production in of the Baltimore Orioles that year. at Morvan Park, riders are judged on the region isn’t meeting demand. The middle leg of the Triple Crown, how well their horses follow specific the Preakness Stakes, packs the stands movements. The original intent of Following The Money Trail at Pimlico yearly with more than dressage was to aid cavalry officers in Generally, horse owners spend much 100,000 horseracing fans. preparing their steeds for battle. of their money locally and regionally. Racing is a big component of the Other popular activities include trail In his 2000 analysis of eight Mary- spectator sport aspect of the horse riding, showing, and eventing, an land counties, agricultural economist industry. In addition to buying food and “equestrian triathlon” that involves Malcolm Commer Jr. at the University paying for parking, fans add to the dressage, show jumping, and navigating of Maryland found that at least excitement of a race by placing bets an obstacle course. Two of the five 75 percent of spending by horse owners on their favorite thoroughbred. Mary- members of the 2004 U.S. Olympic is within their counties of residence and land, Virginia, and West Virginia permit team for eventing were from Virginia, 80 percent is within the state. wagering at their combined 11 race- while a rider from North Carolina Where does this money go? Typi- tracks. In addition, West Virginia’s served as an alternate. cally, it’s spent locally at retailers that tracks offer slot machines, which gen- Some people still keep horses on supply a variety of goods, from har- erate extra revenue and enable them their own property and take care of nesses and saddles to fences and barns. to offer larger purses that attract the them, but others don’t know a thing It also goes to farriers who shoe horses, best competitors. about animal husbandry or equine veterinarians who provide equine care, There are the big spenders who pay health. They view horses as a means trainers, and other service providers. a small fortune to buy or breed horses to an end — an opportunity to enjoy Trail riders usually have paths to for racing and other equestrian sports. the outdoors, spend some time with explore close to home, but they occa- But contrary to popular belief, the horse animals, or get a dose of excitement. sionally travel looking for new territory. industry is not dominated by millionaires. As a result, the “horse farm” emerged Those who enter their horses at eques- The American Horse Council’s study to serve their needs. The Montgomery trian shows and sporting events determined that horse-owning house- County study noted that when horses sometimes also take their dollars on the holds had an annual median income of were just work accessories, they were road. When they travel for competitions, $60,000, putting them squarely in the rarely the primary focus of an agricultural they may spend money on entrance fees, middle-class bracket. Moreover, while operation. Today, taking care of horses parking space and stable rentals, gaso- one-third of these households earned is big business – about 100 horse farms line for vehicles, and hotel rooms. In more than $75,000 a year, one-third provide boarding, training, and instruc- either case, the economic effect is earned less than $50,000. tion in Montgomery, mostly north and similar to tourists visiting Pinehurst, Ahorse owner does need to have a west of the county’s seat in Rockville. N.C., to play golf or the New River sufficient amount of discretionary income Equestrian centers provide similar Va l ley in West Virginia to ride the rapids. to cover expenses. “You have to pay for services in addition to hosting sporting In contrast, the spending of people food, clothing, and shelter before you do events and shows, though they typically who breed horses more closely resem- anything else, whether it’s going to the receive financial assistance from private bles traditional agricultural producers. movies, going out to eat, or riding a horse,” foundations and government agencies Once a breeder with a mare pays a stud says Cindy Wadford, executive director that wish to support equestrian activi- fee to have a stallion supply his seed, the of the North Carolina Horse Council.

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Horse Country loans don’t have a strong busi- The economic effects of horse- Where The Horses Roam ness background,” says Lisa related activities are felt Registered Horses Per 10,000 People Derby Oden, a New Hamp- throughout the Fifth District. Quarter Horses Arabians Paints shire-based consultant for But there are some places Maryland 15.5 5.7 0.3 equine businesses. Oden and where it is more concentrated, North Carolina 50.7 8.2 1.0 others say these firms don’t areas that are affectionately South Carolina 45.4 6.4 1.3 have a business plan or do known as “horse country.” Virginia 32.7 9.1 0.5 other things to demonstrate Since most horses are recre- West Virginia 53.6 8.6 1.5 that their enterprise is more ational in purpose, a lot of them United States 97.3 10.9 1.6 than just a hobby. are found near large population SOURCES: U.S. Census Bureau, American Quarter Horse Association, Arabian Horse Also, borrowers must have centers. “The horses are going Association, American Paint Horse Association sufficient assets to pledge, such to follow the people, and the as equipment and real estate. people are going to be congregated extends into the countryside. Real Horses usually make lousy collateral around urban areas where the good jobs estate values have skyrocketed in com- because there is no commonly accepted are,” says University of Maryland’s munities on the outskirts of urban method of valuing their physical traits. Thomas Hartsock. “In our state, large areas, resulting in huge subdivisions Other sources of capital are avail- concentrations of horses are in central popping up in between horse farms. able for horse-related businesses. They Maryland, literally an hour or an hour “Horses live on relatively high-dollar include the federal Farm Credit System, and a half drive from Baltimore or Wash- acreage as compared to traditional a network of financial institutions that ington, D.C.” Similarly, the counties in farms,” says Hartsock. “It’s expensive specialize in lending to the agricultural North Carolina with the most horses land because people want their horses sector; and the U.S. Small Business are part of major metro areas, including to be near where they live.” Administration’s Microloan program, Greensboro-High Point and Charlotte. This has raised the bar for horse which has more flexible collateral Don’t look for a lot of horse-related ownership in places like Leesburg in requirements. Additionally, loans from spending in big cities, though. People Loudoun County, which is just 25 miles state agricultural departments are usually enjoy their horses in nearby west of Washington, D.C. As the fastest- usually open to the horse industry, suburbs and rural areas where there is growing county in the nation, Loudoun except for those backed by the federal room for trails, stables, equestrian lost 41,848 acres of farmland between Farm Service Agency (FSA). FSA centers, and racetracks. 1987 and 2002, with almost half of that guarantees cannot finance the produc- Some of these communities have loss occurring in the last five years. tion of horses for “nonfarm purposes” developed enough “horse infrastruc- Andrea Heid, program manager of such as racing and showing, nor can ture” to become hubs of equestrian the Virginia Horse Industry Board, thinks they fund nonfarm enterprises like activity. They include Loudoun and tough decisions will have to be made in riding stables. Fauquier counties in Virginia; Baltimore Loudoun. Development could continue Despite these challenges, the horse and Montgomery counties in Maryland; unabated, which could result in only industry continues to thrive in the Fifth and Southern Pines and other parts of higher-income residents being able to District and across the country. Whether the Sandhills region in North Carolina. afford land for their horses, or the county they’re in it for business or pleasure, Some of the clustering is due to could preserve land for agriculture the people who work with horses say it’s favorable climate and terrain, and in through zoning, which has its own costs worth the not inconsiderable trouble and other instances due to lobbying for and benefits. (See the downzoning expense. “Most of the people that I know private and public support of eques- feature in the Summer 2004 issue.) do it because they have a passion for any- trian centers and trails. In addition to access to land, capital thing that’s equine,” says Andrea Heid. Such efforts have become increas- can be hard to get for horse-related “A lot of them say, ‘I used to be rich ingly important as denser development businesses. “Some people looking for before I owned horses.’” RF

R EADINGS Commer, Malcolm Jr. “Characteristics of and Economic The Barents Group. The Economic Impact of the Horse Industry in Variables Associated with the Equine Industry in Selected the United States. American Horse Council, December 1996. Maryland Counties.” Fact Sheet 666, Maryland Cooperative Vukina, Tomislav, Robert Mowrey and Fritz Roka. “Horses: Extension, University of Maryland, 2000. A $704 Million Purse for North Carolina.” College of Agriculture The Wessex Group Ltd. 2001-2002 Study of the Economic Impact of and Life Sciences, North Carolina State University, August 2000. the Equine Industry in Virginia. Virginia Equine Educational Visit www.rich.frb.org/pubs/regionfocus for links to relevant sites Foundation, February 2003. and supplemental information.

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ECONOMICHISTORY The Border Line and the Bottom Line BY BETTY JOYCE NASH

wift Creek has resisted annexa- cities have flourished through ever- The Economics tion by its neighbor, the Town expanding boundaries. The 50 top Sof Cary, N.C., for more than 20 annexation-happy cities tripled their of Municipal years. Anti-annexation advocates say municipal area between 1960 and they want to keep development at 1990. Annexation bay and protect the community’s Charlotte serves as an example. groundwater supply. Its land mass has more than tripled “Cary is nibbling away at Swift since 1970, from 71.5 square miles to Creek,” says Tom Vass, president of its current 268 square miles, thanks the Middle Creek Swift Creek to North Carolina’s liberal annexa- Community Alliance Inc. “Cary’s tion laws. Those laws are among the concept of progress is to put shop- loosest in the nation. ping centers on every surface,” Vass While the history and evolution complains, adding that the runoff of state annexation statutes are pollutes groundwater, affecting resi- murky, they fall into several distinct dents’ wells. categories. People, cities, a judge, The ongoing dispute over Cary’s or a legislative body can decide effort to annex Swift Creek highlights how annexation proceeds. In the similar battles throughout the nation. Fifth District states of Maryland, Annexation brings up a host of emo- West Virginia, and South Carolina, tional and economic issues: people who live in suburbs and use city ameni- ties for free; continued decline of urban tax base; problems of monopoly as cities become bigger providers of services with less competition; and people’s loss of choice when forced annexation overrules preferences.

State Laws Shape Annexation Behavior Annexation is a time-honored way for cities to protect tax base, credit rating, and economic vitality. Some states let cities annex without resi- dents’ permission, especially if resi- dents of land to be annexed already use — or want — city-provided serv- ices such as water and sewer. But some states don’t allow cities to annex. Cities that are surrounded Charlotte, N.C. by already-incorporated areas — pre- has grown geographically venting expansion — are hard- from about 71 square pressed to amass revenue to provide miles in 1970 to some decent services and maintain aging 268 square miles today. infrastructure. North Carolina’s Middle-class people in the last half annexation laws are among the most liberal century have exited cities, siphoning in the United States. off tax base and civic energy. Growing SOURCE: Charlotte-Mecklenburg Planning Commission

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residents of the proposed annexation legislature to get specific authority.” putes are ongoing in Cary, Fayetteville, area get to vote on the issue. Annexation petitions multiplied and Goldsboro, and Winston-Salem. In Virginia, cities can’t annex at all, entire contingents, for and against, The idea that people who live in and a circuit court panel decides on would migrate to the state capital seek- suburbs benefit from economic activ- towns’ boundary changes. North ing special legislation. In 1947 the North ity that characterizes the city is wide- Carolina lets cities, once certain con- Carolina legislature authorized cities to ly accepted. The region couldn’t exist ditions are met, absorb unincorporat- annex, but also allowed the people being without its hub, the city. That creates ed urban areas without permission annexed to force a referendum. The leg- an economic problem of “free riders,” from the affected residents. And in islature established a commission to people who use a city’s goods — its the District of Columbia, which orig- study the issue, and 12 years later passed streets, parks, cultural institutions, inally was created by the ceding of the law that is used today. and the unquantifiable benefits of land from Maryland and Virginia, the “[It’s] based explicitly on the notion city life in general — without paying. issue of annexation is moot. (See side- that people who live in a nearby city are “If I happen to live outside the city bar on the origins of the District of there because the city is there and they limits and commute into downtown Columbia.) share the benefits the city creates by Charlotte, in effect what I’m doing is Naturally, when people get to decide being a cultural and economic center,” taking advantage of services provided by whether to be annexed, as they do in 26 Lawrence says. The rationale is that the the city without paying for those servic- states, they usually nix the idea. Almost whole metro area is a single communi- es,” says Jonathan Wells, capital facilities no one wants to pay the higher taxes ty and the area to be annexed, as a tiny program manager of the Charlotte- associated with living inside city lim- part of the metro area, shouldn’t have Mecklenberg Planning Commission. “If its— or be told where to live. veto power. “There have never been I go out to the park and eat lunch out many states that let cities annex like there, that park is paid for by the city.” Annexation Economics that.” Most states, evident by the num- Suburbanites, however, patronize busi- Few laws dictated annexation behavior ber that require a popular vote before nesses and add to the city’s tax base as until the 20th century, says David annexation, adhere to the idea that well as provide labor. Lawrence, an attorney who is an people ought to have a say so. Another problem with forced expert on the issue at the Institute of That’s a popular notion in North annexation is absence of choice and Government at the University of Carolina, too, and one of the reasons voice. Vass has lived in Swift Creek, 10 North Carolina at Chapel Hill. why its annexation laws recurrently miles south of Cary, since 1978, and “There were many cities incorporat- come under attack, Lawrence notes. has seen bits of Swift Creek pulled ed in colonial times that kept their same North Carolina’s annexation-friendly into the town over time. Cary has boundaries for decades,” he says. laws are continually questioned grown from about 10.6 square miles in “When they did want to annex, it tend- by people who live in territory within 1981 to about 45 square miles by 2002. ed to be ad hoc, where they’d go to the range of a growing city. Annexation dis- Va ss picked out where and how he

Inside the Beltway The location of the nation’s capital was a point of contention for the port of Georgetown. Also, the slave trade was booming in some 25 years, floating from Pennsylvania to New Jersey, among Alexandria, and dissociation from congressional authority allowed other locales, until 1790 when a deal was struck between Alexander that trade to continue until it was outlawed. Hamilton and Thomas Jefferson. In exchange for federal assump- The District is surrounded by mostly flourishing suburbs. But tion of largely northern state debts, the capital would be placed like other old urban centers, Washington D.C. has a higher poverty below the Mason-Dixon Line, along the Potomac River, on land rate than the national average, 17.6 percent compared to 12.1 per- given to the federal government by the two slave-holding states of cent. In the early 1990s, the District faced financial woes that Maryland and Virginia. brought on management by a federal financial control board. With Initially, the area authorized for the new city was 100 miles some 30 percent of its property owned or occupied by the federal square. The first commissioners named the city Washington, after government, that’s a big revenue drain come tax time. However, D.C. the nation’s first president, and decided to call the entire area the levies a complex array of sales taxes to help offset “free rider” District of Columbia, after Christopher Columbus. The area also problems. For example, restaurant meals, rental cars and telephone included the cities of Georgetown and Alexandria. In 1846, the area calling cards come with a 10 percent sales tax. Commercial parking that’s now Alexandria and Arlington County was ceded back to costs an extra 12 percent in local taxes, and like many other big Virginia, shrinking the federal district by one-third, about 32 square cities, D.C. charges hotel guests a hefty tax of 14.5 percent. miles. Apparently, Alexandria merchants had expected to win big Residents of the capital city can vote in presidential elections, through capital connections, but the economic activity never mate- determining who will receive D.C.’s three electoral votes. But they rialized because of disputes over the canal and competition with do not have formal representation in Congress. —BETTY JOYCE NASH

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wanted to live, and yet may become The Politics of Annexation In 1970, Richmond annexed 23 part of an area that differs from his After World War II, annexation activity square miles and 47,000 people of choice. What irritates Vass most is the proliferated. New suburbanites sought Chesterfield County in what would idea that the people most affected services they’d become accustomed to become, in Moeser’s words, “the most don’t have a say. when they flocked to the city before, celebrated municipal annexation in In that vein, economists Gaines during, and immediately following the history.” The annexation seemed sen- Liner and Rob McGregor of the war. In the decade between 1950 and sible on its face, as the suburban area University of North Carolina at 1960, about 90 percent of the nation’s had obvious ties to the city. Yet the Charlotte report: “Since many people cities grew through annexation. action was rife with political intrigue are living in unincorporated munici- Annexation laws are partly linked to and the politics of the day. pal fringe areas specifically to avoid the power of rural areas in the first half The negotiations for annexation paying higher city taxes, annexation of the 20th century as well as to the had been conducted secretly for five effectively thwarts the preferences power delegated to local governments years beforehand by people who want- these residents have revealed in their by the states. In Virginia, where the ed to retain a white majority on the city choice of where to live.” Further, they Jeffersonian idea of the gentleman council, according to Moeser’s book. A note that resources in the city could farmer held sway, cities were thought civil-rights activist sued, protesting go to pay for service to newly of as dens of iniquity where the poor that the annexation violated the 1965 annexed areas, leaving inner city resi- country boy went to get fleeced, jokes Civil Rights Act by diluting black vot- dents worse off. Ted McCormack. He is associate direc- ing strength. Richmond City Council But Liner and McGregor also sug- tor for Virginia’s Commission on Local elections from 1970 to 1977 were sus- gest there could be an optimal level of Government, the body charged with pended. The annexation was upheld by annexation at which per-capita taxes overseeing boundary line changes in the U.S. Supreme Court, which man- and spending are minimized. Liner the state. dated a ward-based voting system. The and McGregor used data from 450 “Thomas Jefferson always referred to 1977 ward elections gave black people municipalities with populations of at cities as fetid sewers,” McCormack says. their first council majority and least 25,000 over the decade between “They were centers of gambling, prosti- Richmond its first black mayor. 1970 and 1980. For the lowest growth tution, illegal trade, and so forth.” Today, many cities in Virginia, as in in per-capita spending and taxes over Virginia’s unique system, where other parts of the nation, are left with 10 years, a city would need to add cities exist separately from counties, old industrial sites, aging infrastruc- land area from 78 percent to 93 per- exacerbates the divide between sub- ture, and a population with lower cent of its area. The authors note that urb and city. The people who pos- incomes than people who live in the the approach does not take into sessed political power were in a posi- suburbs. Nationwide, suburban medi- account that the optimal annexation tion to protect rural counties until an income is 67 percent higher than rate might not be the same for large one-man, one-vote court decisions in central city median income, according and small municipalities. the 1960s gave city populations more to Bruce Katz and Katherine Allen of “If you don’t annex at all, costs per representation. the Brookings Center on Urban and capita tend to be high,” Liner says. Virginia’s unique political geogra- Metropolitan Policy. Today, Richmond “Annex some and they tend to come phy has meant that annexation is encompasses 62 square miles, while down. More annexation than none much more contested than it would neighboring Chesterfield and Henrico tends to reduce per-capita cost. To be in North Carolina or anywhere counties smear out over 400 square have the lowest increase, you have to else because whatever a city gains in miles and 200 square miles, respectively. annex quite a bit.” territory or tax base, the county loses, “The suburbs do not want the At some point, though, inefficien- according to John Moeser. He is a problems of the city,” Moeser says. cies in service provision may develop professor of urban studies and plan- “The upshot is you’ve got cities in as a city keeps getting bigger, and in ning at Virginia Commonwealth Virginia — Petersburg, Richmond — that case, per-capita taxes and spend- University and co-author of Politics experiencing enormous fiscal stress ing will begin to increase with annex- of Annexation: Oligarchic Power in a with a declining tax base, jobs eroding, ation, the authors note. Southern City. cities struggling.” RF

R EADINGS Lawrence, David H. Incorporation of a North Carolina Town. Moeser, John V., and Rutledge M. Denis. Politics of Annexation: Chapel Hill, N.C.: University of North Carolina Institute of Oligarchic Power in a Southern City. Rochester, Vt.: Schenkman Government, 1998. Books, 1982.

Liner, Gaines H., and Rob R. McGregor. “Optimal Annexation.” Visit www.rich.frb.org/pubs/regionfocus for links to relevant sites. Applied Economics, August 2002, vol. 34, no. 12, pp. 1477-1485.

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INTERVIEW Frank Sloan

Editor’s Note: This is an abbreviated version of RF’s con- RF: Much of your research has focused on factors that versation with Frank Sloan. For the full interview, go to influence the cost, quality, and utilization of health care. our Web site: www.rich.frb.org/pubs/regionfocus. Do you think this market is fundamentally different from other markets?

Ty pe “health care” into a Google search and Sloan: There are things that set it apart, but some people you’ll get more than 24 million web pages go off the deep end and say there’s nothing we can learn devoted to the subject. That’s not surprising from other markets. One thing that health care and other given the personal stake that Americans have markets have in common is that people respond to incen- tives. Another thing is that competition may produce some in how the economy supplies this vital service. desirable outcomes. Markets won’t take care of poor people, but they are a way to achieve efficiencies. For most of his career, Frank Sloan has studied What is different about health care is the uncertainty of the health care industry using the analytical consumption. You don’t know today that you might have surgery in two months, so that leads to demand for insurance. tools of a public policy economist. His goal has Insurance stands between the people who provide been to describe how government policies, along health care services and those who use them, but it’s possi- with economic factors, shape the decisions of ble to oversimplify that relationship. Compulsory auto people who provide and purchase health care. insurance is a way that we are able to tax those people who drink a lot and drive under the influence. The difference is After 30 years of teaching and conducting that we find it socially OK — in fact, preferable — to expe- research at universities around the country, rience-rate auto drivers in some states. We wouldn’t do that Sloan returned to near his hometown of in health care. Greensboro, N.C., in 1993 to continue his Another difference in the health care market is the exter- nalities. People are afraid that if somebody coughs they will work at Duke University. get the flu. Those are public health externalities. Another kind is financial externalities. If somebody gets lung cancer Sloan has served on several advisory boards and needs a lung transplant, that is typically done at public and committees, including the editorial board expense. If people are disabled because of their smoking, they get Social Security disability insurance and that is shared of the Journal of American Health Policy and by everyone. Then we have the “bleeding heart” externality. the Physician Payment Review Commission, The fact that I care that a poor person has adequate con- which was formed by Congress to evaluate sumption is something that will not be solved by markets. Medicare’s physician reimbursement system. Also on the list of differences is the “public good” aspect of biomedical research. Much of the improvement in health He also has spent 22 years as a member of the is due to this research, yet a private market will never pro- Institute of Medicine at the National Academy vide all of it. We have relied on patents to provide an incen- of Sciences, where he has co-chaired tive, but they are imperfect solutions. They grant monopoly committees studying nurse staffing and power to a seller, so the quantity supplied is lower and the price is higher than it would otherwise be. vaccine development. His current research interests include alcohol abuse, long-term care, RF: It seems as if there is a similar problem with analyses of the cost-effectiveness of medical providing incentives for vaccine production. technologies, and medical malpractice. Charles Sloan: Vaccines are a case in point. The general impres- Gerena spoke with Sloan on Nov. 8, 2004. sion that many experts have, which I think is correct, is that vaccines are undervalued. Some of the greatest health benefits have come from vaccines. During my lifetime, we no longer talk about getting polio, so we don’t have to

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develop interventions or improvements to the iron lung because we can actually prevent the disease.

RF: Some people have suggested that the government get more involved in the vaccine market as a purchaser.

Sloan: The government already is very involved in being a buyer of childhood vaccines. The problem is that it has such market power that the vaccine price is too low and not enough of an incentive to entice new suppliers. As govern- ment agencies get lower and lower prices for vaccines, manufacturers want to leave the business. The question is how to structure incentives for entry. One suggestion is to pay vaccine manufacturers the social value of their products. That sounds like a good idea, but you are essentially giving economic rents to the manufac- turers. This would be socially objectionable on distribu- tional grounds. Another way to do it is for the government to have in its head what the value of a vaccine is, then negotiate with the manufacturers to get the best price that it can, recognizing that the price will need to increase in order to get sufficient supply.

RF: Another hotly debated topic in health care lately is whether to allow the reimportation of prescription drugs. What are your views on that issue? reduced. There is some evidence that, at least, the elderly Sloan: The United States is a major importer of many goods. are less disabled than they used to be. They are living longer In fact, in trying to resolve the recent flu vaccine shortage, the but not living worse. It’s clear that if you did a report federal government was willing to card on the benefits of improved work with other countries to import “Theoretically, health for the elderly — we’ve done it vaccine. The policy concern about for four diseases — the benefits have importing drugs is mainly motivated managed care is a great idea. grown more than the costs.That is, by attempts to satisfy the interests of Medicare spending has grown less pharmaceutical manufacturers. In practice, it is not so good.” than the value of the benefits. Having said this, drug importa- tion is not a solution to the rising RF: For a while, we tried to cost of prescription drugs. Lower prices abroad reflect the reduce medical costs using managed care and health regulatory policies in other countries. If we want to import maintenance organizations (HMOs). Now there is a drugs subject to price caps in other countries, it would be backlash against that approach and people want more more efficient to impose caps in this country. choices. What is your opinion? According to the concept of comparative advantage, the United States should produce goods and services for which Sloan: The concept is a good one: to provide incentives to it has an advantage and import goods and services for which keep people healthy. If we can take care of people while they it is at a disadvantage. Importing drugs manufactured in our are healthy, then maybe we will spend less when they are sick. country does not represent comparative advantage. Also, given that we have so much insurance, individuals and their doctors have an incentive to use service down to the RF: There has been a lot of discussion about the price of point where the marginal benefit is zero, and that is way too medical care in general. Costs have outpaced overall much care. So theoretically, managed care is a great idea. In inflation by a large margin for some time. Why do you practice, it is not such a good idea. think they are so high? First of all, what incentive does my health plan provider have to prevent illness in the future, when in fact I may not Sloan: First of all, I’m not sure that’s the right measure. Yes, even be around? Some people change jobs, some people get costs have been increasing. But can we say that the bene- married and drop coverage because their spouse has better fits of improved health are worth it? The health of the pop- coverage, etc. When the health benefit is way downstream, ulation is clearly improving. Mortality is substantially the impetus to control diabetes, to control weight, or to PHOTOGRAPHY: LES TODD, DUKE UNIVERSITY LES TODD, PHOTOGRAPHY:

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encourage people to stop smoking is greatly attenuated. RF: Many lawmakers have blamed rising health care A second problem is that we were never able to get costs on “frivolous lawsuits” for medical malpractice and clinical findings in line with health plans. If we know that “defensive medicine” to stave off those lawsuits. Based doing certain things for people with diabetes improves their on your work and other economists’ research, how much health, we never implemented real incentives on a wide- has this really contributed to cost increases? spread basis to give patients and their doctors a reason to do those things. And protocols weren’t refined enough. They Sloan: It has to be very small. First of all, premiums are 1 were just blunt policies like, “You’ve got to see a general prac- to 3 percent of health care expenditures. If you took all the titioner before you can go to a specialist.” But the cardiolo- costs of inputs to hospitals and physicians’ practices, much gist may know more about preventing heart disease. The more is spent on other parts. Labor is much more, yet endocrinologist may know more about diabetes. So now, we don’t say we have a crisis in physician labor. gatekeeping has been gutted. On the defensive medicine front, we have never Athird problem is that managed care never got the developed an operational definition of what we mean by doctors on their side. Some nurse at the other end was that. Presumably, defensive medicine would be care that telling them how to practice medicine. So the doctors were yields a marginal benefit substantially lower than the cost. able to say the quality of care was going down the tubes and If we look at Prostate-Specific Antigen testing for they brought the issue into the legislative arena. Nearly prostate cancer, for example, you could say every time we every state in the country enacted some patient protection get a negative finding that test was a waste, but, obviously, law. This had a chilling effect on the managed care industry. it was not. Then the question is which follow-up biopsy The industry preemptively loosened up. does the benefit exceed cost and which does not. Well, this would require an in-depth study. It also depends on the risk RF: Is there a good way to refine the managed care preferences of the person who is being tested. Some people approach, or should we go back to the drawing board? may have a need to know whether there is something grow- ing inside them and would be willing, even in the absence of Sloan: I think we need to reinvent it. We need to use evi- insurance, to pay. dence-based protocols. Often, these protocols are based on We need to determine whether, in the absence of the doctors getting together and saying, “I think having an annual distortions in the market, this person would have been will- physical is a good thing.” We need evidence. ing to pay for this added diagnostic testing. It’s clear that Evidence does not always lead you to spend less, some people would, so we can’t say that all biopsies are a however. That’s what we had thought before with HMOs. waste. And if we said they were all a waste, we would elimi- But the big dilemma for the future is that the evidence may nate them and throw the doctors out of business. sometimes tell you to do the opposite. As our colonoscopies get better, we may do more of them. As we refine diagnostic RF: You also have researched how the tort system, as well imaging, we may do more. as government regulation and market forces, influences alcohol use. What have you found to be the best deterrents for driving under the influence?

Sloan: Incentives matter and disincentives matter. One of our interests has been how the insurance system affects accident rates. If you have a DUI offense on your record in this state, your premium goes up remarkably and that is quite a deterrent. With “dram shop liability,” the server is held liable if a patron leaves the bar under the influence of alcohol and the server did not take precautions to prevent that person from leaving, and that was the cause of an accident that led to a fatality or life-disabling injury. We found some evidence to suggest that dram shop liability is a deterrent. People at home just conk out and go to sleep. But with people that have to go from point A to point B, the bartender is relatively efficient at prevent- ing that accident. He might take the keys away. He might refuse service. After some point, he may water down the drinks.

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RF: There are some people who national health insurance was adopted continue to drink too much or Frank Sloan at an opportune time in the immedi- smoke cigarettes despite the ate post-World War II period. ➤ Recent Positions deterrents and health risks. Do Once implemented, it is political- J. Alexander McMahon Professor of they understand the risks? Is there ly impossible to take national health Health Policy and Management and any difference in how smokers and insurance away, like Social Security in Professor of Economics, drinkers process information? the United States. To implement the Duke University (1993-present); program, one must overcome sub- Director, Center for Health Policy, Sloan: We should separate drinking stantial political opposition from Law, and Management, Duke University and smoking. Some moderate drink- well-organized stakeholders. This (1998-2004) ing is presumably good for your has been difficult to do in this coun- health. It’s drinking to excess that is a ➤ Previous Appointments try. Perhaps it could have been done problem. We have these various Vanderbilt University (1976-1993); during the Johnson Administration externalities with somebody going University of Florida (1972-1976); when Medicare and Medicaid were out on the highway drunk and driving University of California, Los Angeles implemented and the Democrats off the road. A lot of accidents (1970-1971); RAND Corporation had won the White House by a wide involve a single car, but some of them (1968-1971) margin and controlled both houses don’t. Smoking is different because it of Congress. ➤ Education is clearly bad for your health and B.A., Oberlin College (1964); most of the damage is to the self and RF: Are there particular econo- Ph.D., Harvard University (1969) the immediate family. The external mists who have influenced your effects are very small. ➤ Selected Publications own work? Our most recent research has Author or editor of numerous books found that smokers seem to process on medical malpractice, the cost and Sloan: I would say that it is a type of information differently, in that cer- quality of health care, and other public economist. When I was in graduate tain health events were less impor- policy issues. Author or co-author of school, the best economists were tant in their own predictions of how scholarly articles in such publications incredibly broad. They would know long they would live. But we are now as the Journal of Health Economics; foreign languages. They would know looking at this in much greater detail. New England Journal of Medicine; history. Milton Friedman, Kenneth Are smokers more likely to be risk- Journal of the American Medical Association; Arrow, Paul Samuelson are a few takers? Are they less future oriented? American Economic Review; economists that exemplify this ideal, Do they place less value on good RAND Journal of Economics; and as well as Wa ssily Leontief, who did health? We are finding that they are American Journal of Public Health. input-output analysis. less future oriented and less risk Then I was influenced by averse than nonsmokers. younger economists. My main graduate school advisor was Another way that smokers differ is they seem to be more Martin Feldstein. He was only three years older than me but pessimistic about the future. If you ask them, “What is the very engaged in policy. I would go in with my dissertation probability that we will have double-digit inflation?” or “What and, in 15 minutes, he would run through it all so thoroughly is the probability that we will have another depression like in that I would spend the rest of the day digesting what I had the 1930s?” they are more likely to fear these adverse conse- learned. quences. These events don’t relate to the individual’s smoking Some people have criticized Marty on grounds that his behavior, but may indicate that they feel more at the mercy of models are not sufficiently deep or complicated. But he is external events, that they have less control over their lives. very practical, and he relies on empirical evidence, not just on abstract theorizing. Also, Marty has devoted part of his RF: The United States is one of the few industrialized career to public service. He has that broad kind of knowledge countries without a comprehensive national health care and understands political constraints. He isn’t going to say system. Without considering the merits of such a system, that government is stupid and should stay out of the way. He why do you think we remain unique in this respect? has a lot of common sense. I remember a professor who studied real-business Sloan: To understand why we do not have national health insur- cycles and gave a seminar, one of the last macro seminars ance as others do, one needs to investigate the historical context I had attended. Somebody asked, “How does your model under which this system was adopted in other countries. For fit the recession of 1974?” He said, “I don’t really study example, Germany adopted national health insurance over a those things.” That to me is unacceptable as an econo- century ago as part of Bismarck’s industrialization policy. At mist. I just don’t know what he’s accomplishing if he can’t the time, health care costs were much lower than they are understand real-life phenomena and how to bring his presently and political opposition was weak. In England, tools to bear on what’s going on. RF

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BOOKREVIEW Man and Machine

THE NEW DIVISION OF LABOR: dig deeper into the relationship between information tech- HOW COMPUTERS ARE CREATING THE NEXT JOB MARKET nology and human work. On the first score, it seems clear BY FRANK LEVY AND RICHARD J. MURNANE that some early fears about massive displacement of workers PRINCETON, N.J.: PRINCETON UNIVERSITY PRESS, 2004, 200 PAGES by computers were widely off the mark. Still, it also seems clear that the effect of technology on work has differed REVIEWED BY JOHN A. WEINBERG widely for workers of varying skill levels and occupations. It is this variation that claims the authors’ attention. mong the many famous maxims that have come down to us from the work of Adam Smith is: “The The (Limited) Power of Computers A division of labor is determined by the extent of the The authors emphasize jobs in two broad categories — market.” This statement captures an evolution frequently blue collar and clerical — which accounted for over half observed in the nature of businesses and jobs as economies the U.S. workforce in 1970 but for less than 40 percent and markets grow. In a small market, particularly in a today. The increased mechanization of manufacturing and preindustrial economy, goods were produced and sold in the resulting declines in blue-collar jobs are by now old sto- small shops. All stages of production were carried out by ries. But the decline in the clerical category also has been the same artisans, the most senior of whom may also have striking. Many clerical jobs involve the organization, stor- been the shop’s owner. ing, and retrieving of information. These are tasks that The growth associated with industrialization brought computers handle particularly well, and so the demand for production on a much larger scale. And with that growth in clerical labor has fallen. scale came processes that allowed production to be broken The authors give a number of examples of other jobs in into distinct pieces performed by distinct workers. So one which computers’ comparative advantage has reduced the effect of industrialization was the shift in the distribution relative demand for human input. And not all of these are of work away from artisans who were skilled at and per- clerical or mid-level jobs. Some, like the job of a trader in the formed an array of related tasks, to workers who specialized pits at the London International Financial Futures and in performing one, often relatively simple part of the pro- Option Exchange, were quite highly paid. The exchange duction process. replaced its trading pits with an electronic trade execution These changes originated with the introduction of tech- network in 1999. While the information processing tasks nology that allowed large-scale pro- associated with trading were perhaps duction to take place. That is, there more complex than traditional clerical has long been an interdependency work, it was still the case that comput- between the size of demand for goods ers could do that processing — search- (the extent of the market) and tech- ing for matches between buyers and nology in determining the evolving sellers — more efficiently. nature of work. All decisionmaking, and therefore In The New Division of Labor, Frank most jobs, involves information pro- Levy and Richard Murnane, econo- cessing of some kind. But computers mists at the Massachusetts Institute of are not better than humans at every Technology and Harvard University, kind of information processing. Levy respectively, direct their attention to and Murnane draw some useful dis- the contemporary version of this inter- tinctions. They single out decisions dependence. Their particular focus is that require “rules-based logic” as on the ways in which computers have those that can be easily delegated to changed the workplace. Since the dawn machines. Of course, rules-based of the computer age, many observers logic is simply the raw material of have predicted widespread replacement computer programming. A problem is of machines for human work. broken down into a sequence of state- Levy and Murnane assess the extent ments, the truth or falsehood of to which such predictions have come which can be unambiguously true and, more importantly, attempt to assessed. Many decisions involve

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using data provided as inputs to perform such a sequence of educational reforms, as a source of improved skill-building tests, culminating in a final decision. The authors give mort- for the U.S. workforce. gage underwriting as an example of a problem that, at first Standards-based educational reforms mean different blush, seems quite complex but that is still well suited to things to different people, and Levy and Murnane argue automation. that not all standards are created equal. They are much less The power of computers to solve even complex prob- interested in standards related to particular content areas lems has at times led people to hold out high hopes for than in standards that assess a student’s success in devel- “artificially intelligent” computers that could perform any oping the types of thinking and communication skills nec- decisionmaking task more efficiently than mere humans. essary to do the jobs at which humans still have a compar- In such a vision, there is no limit to the ability of machines ative advantage. And these types of skills don’t lend them- to replace work done by people. Levy and Murnane take a selves as easily to simple, multiple-choice testing. They distinctly different view. They identify an array of deci- describe a program undertaken by a Boston public elemen- sionmaking problems where rules-based logic is not the tary school that has had some considerable success. This basic building block. A key component of this other cate- example makes clear that the kinds of reforms the authors gory of problems is what they call “pattern recognition,” by have in mind are not simple or cheap. They involve a great which they mean the ability to assess a situation and deter- deal of direct student-teacher interaction, as well as guided mine if it fits a previously encountered pattern. Through interaction among students. examples, they show that “situations” can be very complex In the end, the picture Levy and Murnane paint of the things. Consider a driver assessing and reacting to traffic future of the U.S. labor market is not too promising. They conditions, or a prison guard surveying interaction among foresee a continuation of recent trends, involving replace- prisoners and watching for signs of trouble. ment of low-skilled work by technology and a widening Building on pattern recognition, the authors describe gap in earnings between the skilled and unskilled. Given skills and jobs that computers cannot easily replace. the divisive politics of public education, it’s hard to imag- “Expert thinking” involves a body of knowledge and expe- ine sweeping changes in primary and secondary education rience necessary for specialized pattern recognition. In the taking place very rapidly. work of automobile mechanics, computer diagnostics can But many of the authors’ examples show that not all identify many problems encountered by car owners, but jobs involving expert thinking and complex communica- this technological tool doesn’t always provide the answer tion require a college degree. That is, not all such jobs are to the customer’s problem. When it doesn’t, the expert “high-skilled” in the conventional sense of the term. mechanic needs to draw on his experience of similar cases Indeed, general economic trends could ultimately lead to to efficiently search for a solution. Many jobs also require increases in the demand for jobs that do not require high- “complex communication” — the ability to convey and er education but do involve the types of skills the authors understand nuances and subtle differences in meaning emphasize — for instance, jobs that involve face-to-face between statements that may sound very similar. In face- (or voice-to-voice) customer contact. to-face or telephone communication, this skill may involve The New Division of Labor gives a concise description of reading meaning into voice tone or body language. In many just what it means, in the computer age, to say that jobs are businesses, a human customer-service function remains being lost to machines. Computer technology is different in superior to menu-driven, automated alternatives. this regard from earlier technological advances. Since com- puters are likely to continue to be a source of new innova- New Skills for a New Age tions, it may be natural to assume that the labor market Ultimately, Levy and Murnane are most interested in how trends brought about by the information revolution are like- businesses train and how schools teach in a world where ly to continue. But innovations are just that — they’re new rules-based logic allows machines to perform many tasks developments that aren’t anticipated before they appear. and where expert thinking and complex communication are This makes projection of trends into the future a risky busi- the uniquely human skills that keep people employed. On ness. Rather than hoping for a change in the direction of the training side, they describe cases of large businesses, technology, the authors prefer to argue for adapting our like IBM, that make substantial investments in training approach to education to the currently prevailing technolog- their workers. They argue, however, that profit-seeking ical trends. That’s a hard preference with which to argue. RF businesses will in general not provide enough in the devel- opment of expert thinking and complex communication E DITOR’ S N OTE skills. These are general skills that make workers equally Our review of Too Big to Fail: The Hazards of Bank Bailouts by valuable to competitors as to the firm that provides the Gary Stern and Ron Feldman, which appeared in the Fall 2004 issue of skills. So, naturally, firms are reluctant to invest in the Region Focus, stated that the book’s authors failed to address the prob- acquisition of such skills because workers can easily take lems a coinsurance program may face if the Federal Reserve lends liberally them to a new company. Instead the authors look to the from the Discount Window. Actually, Stern and Feldman discuss that issue education system, and in particular to standards-based on pp. 157-158 of their book.

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District Economic Developments BY ROBERT LACY

The Fifth District economy Retail sales, however, remained a weak But the manufacturing news from continued to expand at a solid pace spot. District retailers told us that Maryland was not as upbeat. In in the third quarter of 2004. Payroll higher energy prices were partly to November, General Motors announced blame for lackluster third-quarter sales. it would close its Broening Avenue employment growth was large Discount chains reported particularly assembly plant in Baltimore in 2005. enough to finally nudge Fifth soft sales as higher gasoline prices Approximately 1,100 jobs are expected to District employment above the strained the already-tight budgets of be lost. Built in 1935 and in its heyday peak reached prior to the 2001 lower-income customers. And by late employing more than 7,000 people, the recession. And while retail sales fall, an increasing number of retailers plant was a mainstay of Baltimore’s once were sluggish, output of goods and were expressing concern that a sharp considerable manufacturing economy. rise in heating bills might constrain services overall was nicely higher. spending even further this winter. AJobs Recovery Employment in the District continued conomic growth in Fifth District District Manufacturing Expands to expand in the third quarter. While Estates was relatively strong in the District manufacturers recorded sub- the pace of growth was slower than third quarter of 2004. The broad serv- stantially higher output in the third in the second quarter, year-over- ices sector expanded at a brisk pace, quarter. Our indexes of shipments and year growth in employment was a despite softness in retail sales, and capacity utilization rose throughout the respectable 1.8 percent. With the manufacturing maintained good period. And despite hefty price increases third-quarter growth, payroll employ- momentum through the summer. Per- for some raw materials — most notably ment in the District finally exceeded sonal income and employment moved oil, steel, copper, and lumber — final the prerecessionary peak reached in higher as well, while the District’s goods prices rose only moderately. December 2000. unemployment rate edged lower. By Manufacturing activity began to late fall, economic growth had slowed slow in the fourth quarter. However, State Economic Indexes Up somewhat, but the District’s economic District manufacturers generally re- The Federal Reserve Bank of expansion remained firmly intact. mained optimistic about future sales Philadelphia now publishes indexes of prospects, and a number of them economic performance for all 50 states. Services Sector Expands announced plans to expand production Its coincident indexes are measures of but Retail Soft facilities in 2005. Dell’s plans to build overall economic performance and are The Fifth District’s services sector a computer manufacturing facility in based on payroll employment, unemploy- expanded at a solid pace during the the Triad area of North Carolina was ment rates, average hours worked in third quarter. Continuing gains in cheered in an area of the state staggered manufacturing, and real wage and salary employment and personal income helped by job layoffs in the textiles industry. disbursements. These indexes suggest stoke demand for most District services The new plant is expected to open in that economic activity rose in all District businesses, boosting their revenues the fall of 2005 and eventually employ states in the third quarter but was strong- during the period. 1,500 people. est in North Carolina and West Virginia.

SUVs, Minivans & Pickup Trucks Did You Know. . . Growth in Registrations (1997-2002) 100

You may be a truck driver and not even know it. Most sport-utility vehicles 80 SUVs Minivans Pickup Trucks (SUVs) and minivans are classified as light trucks by the U.S. Department of 60 Transportation because they are built on truck chassis or have truck-like features. If you are one of those SUV “truck” drivers you have lots of company 40

these days. According to the Census Bureau’s 2002 survey of the nation’s trucks, PERCENTAGE 20 in Fifth District states there was about one SUV for every 12 people. 0

-20 WV DC NC MD SC VA NOTE: Growth in pickup trucks in Maryland was 0.2%

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Nonfarm Employment Unemployment Rate Personal Income Third Quarter 2004 (Percent) Third Quarter 2004 Employment % Change 3rd Qtr. 3rd Qtr. Income % Change (Thousands) (Year Ago) 2004 2003 ($ billions) (Year Ago) DC 672 1.6 DC 7.8 7.0 DC 28.3 5.6 MD 2,535 2.1 MD 4.2 4.5 MD 218.6 5.5 NC 3,863 1.2 NC 5.0 6.5 NC 251.2 5.1 SC 1,835 1.3 SC 6.4 7.0 SC 114.3 5.2 VA 3,591 2.5 VA 3.5 4.2 VA 264.7 6.1 WV 736 1.3 WV 5.3 6.2 WV 47.3 5.7 5th District 13,232 1.8 5th District 4.7 5.5 5th District 924.4 5.5 US 131,521 1.3 US 5.5 6.1 US 9,670.6 5.2

Fifth District United States Nonfarm Employment Unemployment Rate Personal Income Change From Prior Year First Quarter 1992 - Third Quarter 2004 Change From Prior Year First Quarter 1992 - Third Quarter 2004 First Quarter 1992 - Third Quarter 2004 4% 8% 9% 8% 3% 7% 7% 2% 6% 6% 1% 5% 5% 4% 0 3% -1% 4% 2% -2% 3% 1% 1992 1995 1998 2001 2004 1992 1995 1998 2001 2004 1992 1995 1998 2001 2004

FRB—Richmond FRB—Richmond Coincident Economic MD VA NC WV Services Revenues Index Manufacturing Shipments Index Activity Index SC First Quarter 1994 - Third Quarter 2004 First Quarter 1994 - Third Quarter 2004 (July 1992=100) 40 40 150 30 30 145 20 20 140 10 10 135 0 0 130

-10 -10 125

-20 -20 120

-30 -30 115 1994 1996 1998 2000 2002 2004 1994 1996 1998 2000 2002 2004 1998 1999 2000 2001 2002 2003 2004

NOTES: SOURCES: 1) All data series are seasonally adjusted. Income: Bureau of Economic Analysis, U.S. Department of Commerce, http://www.bea.doc.gov 2) FRB-Richmond survey indexes are diffusion indexes. Positive numbers represent expansion, Unemployment rate: LAUS Program, Bureau of Labor Statistics, U.S. Department of Labor, negative numbers contraction. http://stats.bls.gov 3) State nonfarm employment estimates are based on surveys of establishments. These employment Employment: CES Survey, Bureau of Labor Statistics, U.S. Department of Labor, http://stats.bls.gov figures differ from those used to calculate state unemployment rates. Coincident economic activity index: Federal Reserve Bank of Philadelphia, http://www.philadelphiafed.org For more information, contact Robert Lacy at 804-697-8703 or e-mail [email protected].

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District of Columbia BY ANDREA HOLLAND

mong Fifth District jurisdictions, economic activity A during the current recovery has been relatively weak Payroll Employment Growth in the District of Columbia. The labor market and house- hold and business financial conditions remain subdued, and Total Payroll Employment

performance of the residential real estate market continues Construction to lag activity districtwide. Leisure and Hospitality

Since the end of the 2001 recession, District of Professional and Business Services Columbia job numbers have expanded 2.3 percent, the Government third strongest growth rate districtwide. Measures of Education and Health Services

payroll employment in the District of Columbia, however, Financial Activities mostly reflect increases in commuters from Maryland and Trade, Transportation, and Utilities Virginia into the city, rather than resident job growth. Information Because commuters cloud the job growth numbers, an Manufacturing

alternative indicator of labor market conditions is initial -25.0 -20.0 -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 20.0 25.0 unemployment insurance claim statistics. This measure 4th Quarter 2001 - 3rd Quarter 2004 shows that initial claims have dropped only 15.4 percent Percent Change in Payroll Employment by Industry Sector during the recovery — a relatively shallow decline com- SOURCE: Nonfarm Payroll Employment, BLS/Haver Analytics pared to the Fifth District decline of 45.8 percent, sug- gesting a comparatively weaker labor market picture.

With fewer residents holding jobs, measures of per- Percent Change sonal income in the District of Columbia have also stag- at Annual Rate From nated since the start of the recovery. Incomes have grown 3rd Qtr 2nd Qtr 3rd Qtr only 3.8 percent since late 2001, the slowest rate among 2004 2004 2003 Fifth District jurisdictions. Nonfarm Employment 672.0 1.0 1.6 Manufacturing, NSA 2.6 0.0 -1.3 Not all economic news was bad for District of Professional/Business Services 145.8 3.6 3.1 Columbia households, though. Personal bankruptcies Government 232.1 2.3 0.9 have declined 22.4 percent — the largest drop among Civilian Labor Force 301.2 0.6 -0.4 Fifth District jurisdictions. 3rd Qtr 2nd Qtr 3rd Qtr 2004 2004 2003 Adding to this good news, business bankruptcies in Unemployment Rate 7.8 7.3 7.0 D.C. have also fallen the most districtwide — easing 52.2 Building Permits, NSA 335 760 182 percent during the recovery period. In contrast, venture Home Sales 15.2 17.9 16.1 capital investment has lessened. Compared to late 2001, capital inflows stand 65.7 percent lower. NOTES: Nonfarm Employment, thousands of jobs, seasonally adjusted (SA); Bureau of Labor Statistics (BLS)/Haver Analytics Manufacturing, thousands of jobs, SA; BLS/Haver Analytics Switching gears, D.C.’s residential real estate market Professional/Business Services, thousands of jobs, SA; BLS/Haver Analytics Government, thousands of jobs, SA; BLS/Haver Analytics has continued to move ahead during the recovery, but not Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics Unemployment Rate, percent, SA; BLS/Haver Analytics at the breakneck pace as seen in other district states. Building Permits, number of permits, NSA; U.S. Census Bureau/Haver Analytics Home Sales, thousands of units, SA; National Association of Realtors® Building permits have risen steadily by 7 percent — the second smallest growth rate in the Fifth District. Existing home sales activity posted a 16.9 percent growth rate during the same time period but trailed districtwide growth of 42.3 percent.

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Maryland U BY ANDREA HOLLAND

hree years into the recovery, the latest data suggest Payroll Employment Growth T that Maryland’s economy has rebounded quickest among Fifth District states. Nearly all indicators of Total Payroll Employment the labor market and financial conditions have posted Leisure and Hospitality strong growth.

Education and Health Services According to the Bureau of Labor Statistics, business Construction hiring in Maryland has been robust over the current Financial Activities recovery. Payrolls in the state have expanded 2.7 percent Professional and Business Services since late 2001, the second strongest growth rate

Government districtwide. By sector, leisure and hospitality payrolls have rebounded the most, while manufacturing and infor- Trade, Transportation, and Utilities mation job performance has been the weakest, still show- Information ing a net loss. Manufacturing

-15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 Tracking the aggregate pickup in hiring, initial unem- ployment insurance claims have fallen 37.9 percent during 4th Quarter 2001 - 3rd Quarter 2004 Percent Change in Payroll Employment by Industry Sector the recovery, exceeding the decline nationwide. Also positive, personal bankruptcy filings have declined 21 SOURCE: Nonfarm Payroll Employment, BLS/Haver Analytics percent, marking the second largest drop districtwide.

Personal income is also a beneficial gauge of growth. Percent Change Over the course of the recovery, income growth has at Annual Rate From expanded 7.4 percent in Maryland, ranking highest among 3rd Qtr 2nd Qtr 3rd Qtr district states and coming in well above the national 2004 2004 2003 growth rate of 4.8 percent. By industry, earnings expanded Nonfarm Employment 2,535.4 2.7 2.1 the most in management of companies and enterprises, Manufacturing, NSA 144.4 -2.6 -0.7 and real estate and rental and leasing. Professional/Business Services 374.0 2.1 3.9 Government 466.0 4.0 0.3 Real estate markets continue to boom in the state. Civilian Labor Force 2,952.6 0.6 1.6 Existing home sales in Maryland currently total 30.2 per- cent more than at the beginning of the recovery. Likewise, 3rd Qtr 2nd Qtr 3rd Qtr the number of new building permits issued has expanded, 2004 2004 2003 though not as fast as in other district states. Unemployment Rate 4.2 3.9 4.5 Building Permits, NSA 7,435 7,636 6,602 Outside of the real estate market, bankruptcy data Home Sales 154.1 146.0 143.8 suggest broad improvement at other business establish- ments. The number of business bankruptcies has fallen NOTES: Nonfarm Employment, thousands of jobs, seasonally adjusted (SA); Bureau of Labor Statistics (BLS)/Haver Analytics 36.5 percent lower over the course of the recovery. On a Manufacturing, thousands of jobs, SA; BLS/Haver Analytics Professional/Business Services, thousands of jobs, SA; BLS/Haver Analytics less positive note, however, the only measure not to Government, thousands of jobs, SA; BLS/Haver Analytics Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics improve in Maryland — or in any other district state for Unemployment Rate, percent, SA; BLS/Haver Analytics Building Permits, number of permits, NSA; U.S. Census Bureau/Haver Analytics that matter — was venture capital activity, where inflows Home Sales, thousands of units, SA; National Association of Realtors® have declined by about one-third.

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h North Carolina BY ANDREA HOLLAND

orth Carolina businesses have enjoyed broad gains N during the current recovery period, but a rebound in Payroll Employment Growth labor market and household financial conditions has yet to fully materialize. Total Payroll Employment Education and Health Services Growth in nonfarm payrolls at North Carolina Professional and Business Services establishments (0.3 percent) has matched West Virginia’s Financial Activities during the course of this recovery — posting the weakest Leisure and Hospitality growth rates in the Fifth District. By sector, education and Government health services have posted the strongest gains, while goods-producing sectors such as manufacturing, and Trade, Transportation, and Utilities natural resources and mining recorded negative job Construction growth. Information Natural Resources and Mining More positively, initial unemployment insurance claims Manufacturing in North Carolina — a measure of future labor market -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 activity — have decreased 48.9 percent since the end of 4th Quarter 2001 - 3rd Quarter 2004 the last recession, the largest decline in the Fifth District. Percent Change in Payroll Employment by Industry Sector SOURCE: Nonfarm Payroll Employment, BLS/Haver Analytics Slow job growth has weighed on North Carolina house- holds in the last few years. Personal income growth has been weaker than in all but one other district jurisdiction since the end of the last recession, recording only a Percent Change 4.7 percent gain. Earnings have also expanded modestly, at Annual Rate From with weakness persisting in construction, retail trade, 3rd Qtr 2nd Qtr 3rd Qtr and transportation and warehousing. 2004 2004 2003 Nonfarm Employment 3,862.5 2.3 1.2 Weak income growth is likely a reason personal bank- Manufacturing, NSA 582.2 -0.8 -2.4 ruptcies have risen; new filings stand 5.2 percent higher Professional/Business Services 443.9 2.4 4.3 than at the end of the recession – marking the second Government 654.6 -0.1 0.8 slowest recovery rate districtwide. Civilian Labor Force 4,178.2 -2.1 -1.7

Indicators of the financial health of North Carolina 3rd Qtr 2nd Qtr 3rd Qtr 2004 2004 2003 firms were more encouraging. Business bankruptcies have Unemployment Rate 5.0 5.4 6.5 declined 37.9 percent over the recovery, the second Building Permits, NSA 24,137 24,664 20,761 strongest contraction districtwide. And venture capital Home Sales 361.7 337.4 307.9 inflows into North Carolina stand only 19.3 percent lower than at the beginning of the recovery — the second NOTES: smallest decrease among district jurisdictions. 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 Conditions in real estate markets were also positive. Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics Unemployment Rate, percent, SA; BLS/Haver Analytics The number of third-quarter building permits exceeded Building Permits, number of permits, NSA; U.S. Census Bureau/Haver Analytics Home Sales, thousands of units, SA; National Association of Realtors® the number authorized in the last quarter of the 2001 recession by 32.6 percent. In addition, existing home sales in North Carolina have expanded 52.9 percent, the strongest increase districtwide.

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South Carolina o BY ANDREA HOLLAND

n economic upturn appears to be taking hold in South Payroll Employment Growth A Carolina, but the state has yet to regain footing lost during the last recession. The most recent information Total Payroll Employment suggests that employment activity and household and Education and Health Services business conditions in South Carolina remain short of Financial Activities their peak, though growth in the residential real estate Leisure and Hospitality market remains robust. Professional and Business Services South Carolina payrolls have picked up by 1.7 percent Government during the current recovery – slightly below the districtwide Construction average of 1.8 percent. By sector, education and health Trade, Transportation, and Utilities services, and financial activities have bounced back the Information most, while growth in manufacturing, and natural resources Manufacturing and mining jobs remains in negative territory. Natural Resources and Mining The sluggish job market recovery is reflected in South -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 Carolina’s initial unemployment insurance claims. 4th Quarter 2001 - 3rd Quarter 2004 Percent Change in Payroll Employment by Industry Sector Although claim submittals have declined since the start of the recovery, the rate of decline has been slightly SOURCE: Nonfarm Payroll Employment, BLS/Haver Analytics slower in South Carolina than it has been districtwide.

Despite lackluster job growth, earnings have risen in Percent Change almost all industry sectors since the end of the recession at Annual Rate From – including manufacturing – boosting total personal 3rd Qtr 2nd Qtr 3rd Qtr income in the state. Personal income has expanded 2004 2004 2003 5.6 percent in South Carolina since the fourth quarter Nonfarm Employment 1,834.9 -0.2 1.3 of 2001, outpacing the nationwide gain of 4.8 percent. Manufacturing, NSA 270.4 -1.1 -1.5 Professional/Business Services 192.6 1.5 1.5 Notwithstanding solid income growth, personal bank- Government 334.6 5.1 1.7 ruptcy filings have risen 2.3 percent higher during the Civilian Labor Force 2,072.6 3.4 3.1 recovery period.

3rd Qtr 2nd Qtr 3rd Qtr Business bankruptcies have also continued to climb 2004 2004 2003 during the expansion – filings in South Carolina have Unemployment Rate 6.4 6.5 7.0 risen 17.1 percent higher, the biggest gain districtwide. Building Permits, NSA 10,821 11,249 9,703 In other business news, venture capital investment Home Sales 165.5 165.5 153.6 into South Carolina has been spotty during the recovery, posting two quarters of flat inflows. 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 But not all news was glum on the business front. Turning Government, thousands of jobs, SA; BLS/Haver Analytics Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics to real estate, new building permits have continued to Unemployment Rate, percent, SA; BLS/Haver Analytics Building Permits, number of permits, NSA; U.S. Census Bureau/Haver Analytics climb during the recovery, with South Carolina recording Home Sales, thousands of units, SA; National Association of Realtors® the second largest expansion districtwide. Likewise, exist- ing home sales continue to set records, coming in 45.9 percent above the fourth quarter of the 2001 level.

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u Virginia BY ANDREA HOLLAND

irginia’s economy has rebounded sharply since the V end of the 2001 recession. The employment situa- Payroll Employment Growth tion and financial conditions of Virginia households have improved markedly and the real estate market continues Total Payroll Employment to forge ahead. Financial conditions have brightened Construction at Virginia firms as well, though gains have been less Financial Activities pronounced. Education and Health Services Professional and Business Services Since the end of the recession, Virginia firms have Government boosted payrolls by 2.9 percent, the best recovery among Leisure and Hospitality district states. Also positive, third-quarter unemploy- ment insurance claims were about half the amount Trade, Transportation, and Utilities recorded in the last quarter of the recession, marking the Natural Resources and Mining second best pickup districtwide. Manufacturing Information

Employment gains over the recovery period have been -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 centered in the construction and financial activities 4th Quarter 2001 - 3rd Quarter 2004 sectors, reflecting a booming real estate market. Existing Percent Change in Payroll Employment by Industry Sector home sales have expanded 36.3 percent and new building SOURCE: Nonfarm Payroll Employment, BLS/Haver Analytics permits have risen 38.2 percent since the end of the 2001 recession.

Strong job creation has boosted earnings in Virginia Percent Change households. Personal income has grown 6.8 percent since at Annual Rate From the end of the 2001 recession, the second fastest 3rd Qtr 2nd Qtr 3rd Qtr districtwide. Earnings expanded the most in construction, 2004 2004 2003 management of companies and enterprises, and real estate Nonfarm Employment 3,591.0 1.0 2.5 and rental and leasing — again reflecting continued Manufacturing, NSA 295.4 -2.6 -2.4 strength in residential real estate. Professional/Business Services 581.0 4.7 5.8 Government 654.0 4.0 2.3 Higher earnings have also limited personal bankrupt- Civilian Labor Force 3,842.1 -0.2 1.6 cies in Virginia — third-quarter filings are 5.6 percent lower than at the start of the recovery, marking the third 3rd Qtr 2nd Qtr 3rd Qtr 2004 2004 2003 largest drop districtwide. Unemployment Rate 3.5 3.5 4.2 Building Permits, NSA 16,125 17,237 14,230 The positive news from the household side is slowly Home Sales 203.2 200.4 185.8 making its way to Virginia businesses. Business bankruptcy filings have moderated since the last quarter of 2001, though NOTES: only by a modest 1.5 percent, the second weakest decline Nonfarm Employment, thousands of jobs, seasonally adjusted (SA); Bureau of Labor Statistics (BLS)/Haver Analytics Manufacturing, thousands of jobs, SA; BLS/Haver Analytics districtwide. 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 In contrast to all this good news, Virginia continues Building Permits, number of permits, NSA; U.S. Census Bureau/Haver Analytics Home Sales, thousands of units, SA; National Association of Realtors® to experience weak venture capital inflows, recording the most pronounced contraction among district states.

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West Virginia w BY ANDREA HOLLAND

ecent economic data suggest that West Virginia’s Payroll Employment Growth Reconomy has expanded slowly during the current recov- ery. Indicators of employment activity and household and Total Payroll Employment business financial conditions have yet to perk up, though Leisure and Hospitality real estate activity was positive across the board. Education and Health Services Financial Activities Payroll employment has risen only 0.3 percent in Government West Virginia during the current recovery, tying North Carolina for the weakest growth districtwide. Some sectors Professional and Business Services have posted solid gains — leisure and hospitality, and Trade, Transportation, and Utilities education and health services — but the jobs performance Construction remains weak in the information and manufacturing sectors. Natural Resources and Mining Manufacturing Lackluster job growth shows through to the state’s Information unemployment insurance statistics. Although third-quar- ter initial claims numbered 32.5 percent fewer than claims -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 at the start of the recovery, the rate of improvement in 4th Quarter 2001 - 3rd Quarter 2004 Percent Change in Payroll Employment by Industry Sector West Virginia remains well below both the national and district average. SOURCE: Nonfarm Payroll Employment, BLS/Haver Analytics

With sluggish job growth, income measures have also been slow to improve in the state. Personal income Percent Change has expanded only 5.5 percent over the course of the at Annual Rate From recovery. Earnings rose modestly in most industries, 3rd Qtr 2nd Qtr 3rd Qtr but declines were recorded in transportation and warehous- 2004 2004 2003 ing, mining, utilities, construction, and information. Nonfarm Employment 736.4 5.2 1.3 Unfortunately, the modest gain in earnings did not pull Manufacturing, NSA 63.4 -3.5 -1.6 down the rate of personal bankruptcy filings, which stand Professional/Business Services 57.0 0.7 1.7 28.3 percent higher than in late 2001. Government 144.0 9.4 1.3 Civilian Labor Force 802.7 2.9 1.9 On the flip side, the number of business bankruptcy fil- ings have decreased 27.9 percent during the recovery — 3rd Qtr 2nd Qtr 3rd Qtr exceeding the national decline. But other indicators of 2004 2004 2003 business activity are less encouraging. Venture capital Unemployment Rate 5.3 5.2 6.2 investment remains generally stagnant in West Virginia — Building Permits, NSA 1,466 1,544 1,291 inflows over the current recovery would be best character- Home Sales 37.6 31.6 31.9 ized as spotty.

NOTES: Nonfarm Employment, thousands of jobs, seasonally adjusted (SA); Bureau of Labor Statistics (BLS)/Haver Analytics Real estate activity continues to forge ahead though. Manufacturing, thousands of jobs, SA; BLS/Haver Analytics Professional/Business Services, thousands of jobs, SA; BLS/Haver Analytics Existing home sales have grown 33.3 percent since the start Government, thousands of jobs, SA; BLS/Haver Analytics Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics of the recovery period. Also positive, housing permits have Unemployment Rate, percent, SA; BLS/Haver Analytics Building Permits, number of permits, NSA; U.S. Census Bureau/Haver Analytics expanded at a breakneck pace in West Virginia, posting Home Sales, thousands of units, SA; National Association of Realtors® the strongest growth rate districtwide. For more information regarding state summaries, call 804-697-8273 or e-mail [email protected].

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Opinion The Broken Window Fallacy BY AARON STEELMAN

lorida was ravaged by four major hurricanes in 2004. Which scenario seems more desirable? Most would say According to the Insurance Information Institute, that scenario No. 1 is clearly preferable. But those who argue F victims of the storms filed more than $22 billion in that the hurricanes are good for Florida’s economy would lead insurance claims. That exceeds the amount of payouts follow- you to believe that scenario No. 2 is just as good if not better. ing 1992’s massive Hurricane Andrew and is roughly two- How could they believe something so seemingly unrea- thirds the $32 billion in claims resulting from the terrorist sonable? Perhaps these people are concerned about income attacks of Sept. 11, 2001. distribution, and believe that the hurricanes will have egali- The hurricanes that hit the Sunshine State were clearly a tarian effects. After all, much of the property destroyed tremendous personal disaster, killing dozens and displacing belonged to relatively wealthy people, while many of the thousands more from their homes. But they were also a major rebuilding jobs will go to lower- and middle-income people. financial setback, right? Not according to some reporters and Another explanation is that they have fallen prey to what analysts. the 19th century French economist Frederic Bastiat called In September, USAToday ran a story headlined “Economic the “broken window fallacy.” In one of his most widely cited Growth from Hurricanes Could Outweigh Costs.” Among the essays, Bastiat asks the reader to consider the example of a people interviewed for the story was Steve Cochrane, fictional character named James Goodfellow. managing director at Economy.com. “It’s a perverse thing … Goodfellow has a rambunctious son, who one day breaks there’s real pain,” he said. “But from an economic point of a window in the family’s house. The repairman who replaces view it’s a plus.” the window will be made better off, but how about The places destroyed by the storms will need to be Goodfellow and society as a whole? rebuilt, Cochrane noted. And according to some estimates, If Goodfellow “had not had a windowpane to replace, this will mean 20,000 new construc- he would have replaced, for example, tion jobs, not to mention large his worn-out shoes or added another expenditures on building materials “Those who argue that book to his library,” writes Bastiat. and telecommunications equipment. In short, the money that was spent What this ignores, though, is how hurricanes are good for Florida’s repairing the window could have those resources would have been been spent in another, more produc- spent otherwise. Sure, a lot of money economy have fallen prey to the tive way. will go toward the rebuilding effort. Not only that: Society, in general, But the key word here is “rebuilding.” broken window fallacy.” does not benefit from the broken The construction workers in Florida window and its subsequent repair. are not putting up new buildings. “To break, to destroy, to dissipate is They are simply replacing those that have been destroyed. not to encourage national employment,” writes Bastiat. More No new net wealth is being created. In fact, as the insurance to the point, “Destruction is not profitable.” claims make clear, more than $22 billion was lost because of the When analyzing the economic effects of a certain action storms. or event, Bastiat reminds us that it is important to pay atten- In the absence of the storms, that money could have gone tion to both “what is seen” and “what is not seen.” In the case toward any number of productive uses. But instead it will be of Goodfellow, what is seen is the money being spent to spent to return Florida to its pre-hurricane condition. repair the window. What is not seen is how that money would To illustrate this point, consider the following two scenar- have been spent otherwise. Similarly, in the case of Florida, ios. First, $22 billion is spent on college scholarships for gifted it’s easy to see the billions of dollars going toward recon- but poor students in Florida and other parts of the Southeast. struction efforts, but more difficult to see how those That money will fund their educations, enabling them to resources could have been put toward more useful ends. acquire better-paying jobs than they would have otherwise. This second step — considering what is not seen — often And some may even go on to start their businesses. Second, eludes many observers and leads them to spurious conclusions $22 billion is spent rebuilding houses, hospitals, and retail cen- that upon closer inspection are obviously wrong. When you ters that were destroyed by the storms, while in the meantime hear someone argue that destruction is good for the economy people live at shelters or with family members, forgo medical — and you almost certainly will the next time a natural disas- care or seek it at more distant facilities, and shop at less ter strikes — remember the case of the broken window. It’s favored stores. a simple example, but one that yields important insights. RF

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NEXTISSUE

Affordable Housing Interview House prices have been rising for several years. That has A conversation with economist Thomas been great for homeowners. But how have non-homeowners, Schelling of the University of Maryland. especially lower- and middle-income people, been affected A past president of the American Economic by this trend? Is there a lack of affordable housing in the Association, Schelling’s research has spanned Fifth District — and if so, what is causing the shortage and a number of areas, including conflict and what can be done about it? bargaining theory, racial segregation, military strategy, and climate change.

Underground Economy Economic History When people think about the underground economy, drugs The furniture industry has been a large and prostitution often come to mind. But the underground part of North Carolina’s economy for more economy is much larger than these illicit activities. When than a century. But how and why did it you pay a handyman to fix a leaky sink or a neighborhood kid develop there? A look at the history of to mow your lawn, and that income goes unreported, those this important industry. transactions become part of the underground economy. How large is the underground economy in the region? Jargon Alert And is it necessarily a bad thing? Many people think of the economy as a “zero-sum game” — one person wins and Falling Dollar the other one loses. But most economic The dollar has been falling against other currencies for several transactions are actually positive sum months. It’s no surprise that this is affecting Fifth District games. We’ll explain why. business — but how depends on whom you ask. We’ll survey a number of sectors, from manufacturing to agriculture to tourism, to find out what the falling dollar means to them.

Sticky Prices The prices of some goods, such as gasoline, change almost daily. Others, like newspapers, remain constant for years. The latter is an example of the phenomenon known to economists as “sticky prices.” Models that account for Visit us online: sticky prices are important in formulating monetary policy. We’ll review the research in this area with a focus on the www.rich.frb.org/pubs/regionfocus work of Richmond Fed economist Alexander Wolman. •To view each issue’s articles and web-exclusive content

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The Spring 2005 Issue will be published in April. Winter 05 FINAL Covers1/21.ps - 1/21/2005 8:13 AM Region Focus 2004 Highlighting Business Activity in the Fifth District

Cover Story Cover Story SPRING 2004, Hanging by a Thread Tough Choices A Look Inside America’s The Peculiar Economics of 8, NO. 1 8, NO. Struggling Manufacturing Health Care Sector Economic History

VOL. Economic History Sold, American! Inside the

Origins of Black Business Tobacco Auctions VOL. Districts Interview Interview James Buchanan, Nobel 8, NO. 2 Randall Krosner, Professor Laureate Economist from of Economics, Graduate George Mason University School of Business, WINTER 2004, University of Chicago

Cover Story Cover Story F Which Way Now? The Creative Class ALL 2004, The Economic Odyssey Are Technology, Talent, and 8, NO. 3 8, NO. of Displaced Workers Tolerance the Keys to Economic History Healthy Cities?

VOL. The Economic Impact of Economic History Historically Black Colleges Unionization in West VOL. and Universities Virginia’s Coal Industry

Interview Interview 8, NO. 4 Kenneth Elzinga, Former Richmond Fed Professor of Economics at President Al Broaddus and the University of Virginia Richmond Fed Economist Tom Humphrey SUMMER 2004,

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