Regular Features
The San Francisco Region's
Larger
and More Diverse State Economies
Tend to Closely
Follow the National Economy
- Over the past year, the San Francisco Region recorded the
fastest employment growth of the eight FDIC Regions.
- Nevada, Utah, Washington, Arizona, Oregon, and California,
states that generally expand when the national economy does, are
all growing much faster than the nation as a whole.
- States in the Region with more diverse economies tend to be
expanding more rapidly than states that have less diverse
economies, especially those that are more dependent on natural
resource-based industries.
- Nevada, the Region's least diverse economy, is the
fastest-growing state in the nation because of strong growth in
gaming, tourism, and construction. However, the state's heavy
dependence on these industries continues to warrant close
monitoring.
The San Francisco Region's Expansion Keeps on
Rolling
The San Francisco Region, fueled by strong job growth in the
Region's larger states, continues to outpace the nation and the
other seven FDIC Regions. Total nonfarm payroll employment for the
Region grew by 669,000, an increase of 3.0 percent over the
12-month period ending October 1997. Over the same period, the
nation's employment grew at a 2.1 percent annual rate. Performance
across the Region's states is as follows:
- Outperforming--The Region's six fastest-growing states
are Nevada, Arizona, Utah, Washington,
Oregon, and California (listed in order of employment
growth rates). These states, which are the most populous states in
the Region, added jobs at a very fast pace, 2.7 percent or better,
over the past year.
- Lagging--Idaho, Montana, and Alaska
(ranked by growth rates) all grew more slowly than the nation over
the 12 months ending October 1997. Just two years ago, Idaho and
Montana were among the nation's fastest-growing states.
- Weak--Wyoming and Hawaii ranked
forty-ninth and fiftieth, respectively, in job growth over the past
year. While Wyoming reported a small increase in employment, Hawaii
reported a slight loss.
Key Relationships between State and National Employment
Growth
This article examines several factors that may help to explain why
the Region's six most populous states tended to outperform the
least populous states over the past year. The analysis focuses on
three factors:
- The historical correlation between a state's employment growth
rate and the national employment growth rate;
- The diversity of state economies compared with the national
economy; and
- The health of key industrial sectors in a state.
Understanding these three factors may provide insights into both
current and future state-level economic performance. Consequently,
it is important to review these indicators because of their
potential relationship to state-level economic conditions, which in
turn play an important role in state-level banking industry
performance, especially for community banks. In addition, these
three factors may be useful for analyzing state economic trends in
the event of a downturn in the national economy.
While few economists are predicting a downturn in the U.S. economy
in the near future, the recent disturbances in the financial
markets both at home and abroad have given rise to concerns about
the path the national economy will take over the next several
years. Within the Region, which has a large share of U.S.
high-technology manufacturing, the slowdown in high-tech exports to
Asia in 1997, combined with the weakened economic conditions of key
trading partners like South Korea, already has resulted in slightly
lower estimates of growth for California's economy in 1998. States
like Hawaii and Nevada, with a heavy dependence on tourism, also
could be susceptible to reduced travel and spending by Asian
tourists.
Measuring the Linkage between State and National Employment
Growth
Clues to state-level economic behavior can be found by correlating
past state economic performance with national economic trends. One
way to quantify this relationship is to compare the correlation, or
comovement, over time between the employment growth rates for the
nation and for the Region (or a state). This measure, or
correlation coefficient, for a series like nonfarm payroll
employment growth rates, can be used to evaluate the strength of
the relationship. The measure also shows whether the relationship
is positive or negative. A correlation coefficient of 1 indicates
that a Region's employment growth rate is perfectly positively
correlated with that of the nation, meaning that when the nation's
economy moves up (or down) the Region follows that movement.
Conversely, a correlation coefficient of -1 indicates perfect
negative correlation, such that when the nation's economy improves,
the Region's economy worsens. A correlation coefficient of zero
indicates that there is no statistical relationship between
movements in employment in the nation and the Region.
Over the past 25 years the San Francisco Region's employment growth
rate has been fairly closely correlated with that of the nation, as
shown in Chart 1. The correlation
coefficient for the Region's and the nation's employment growth
rates over the 25-year period was 0.91. Moreover, as shown in Chart 2, the Region's employment growth rate
correlated more closely with the national employment growth rate
than did that of any individual state in the Region.
Larger States in the Region Generally Follow the National
Economy More Closely than Smaller States
Employment growth rates in Arizona, Nevada, Oregon, California,
Utah, and Washington (ranked from highest to lowest) all exhibited
a high degree of correlation (above .70) with the national
employment growth rates over the 25-year period. These states also
are the most populous in the Region; in 1996 their populations
ranged from 1.6 million in Nevada to 31.9 million in California. As
indicated in Chart 2, these more populous states show a much closer
relationship to the nation's employment growth pattern than do the
five least populous states (populations ranging from 500,000 to
nearly 1.2 million).
The employment growth rates in three of the least populous states,
Idaho, Montana, and Hawaii, do show a modest positive relationship
to employment growth rates for the nation. However, movements in
Alaska and Wyoming show only a weak correlation with national
employment growth rates. These two states are heavily dependent on
natural resource-based employment, and they both have a large share
of government jobs. Employment growth rates in these two sectors
typically do not show a close correlation with national rates.
Alaska's relationship to national employment growth after the oil
crisis of the early 1970s is especially unusual. Alaska is the only
state in the Region that exhibited a negative correlation with
national employment growth over the past 25 years. This means that
as the nation's economy lost jobs, Alaska's economy tended to add
jobs. Alaska is a major oil producer; consequently, it benefits
from high or rising oil prices, conditions that dampen economic
performance in most of the nation.
Implications: The six most populous states tend to move in
tandem with the national economy, and they are currently among the
six fastest-growing states in the nation. Their strong
relationship to the national economy suggests that the economies of
Arizona, Nevada, Oregon, California, Utah, and Washington (ranked
by their correlation to the national economy) are likely to
continue to follow national conditions. Despite this tendency,
it is clear that state economies do not always follow the national
economy. Within the Region, even the states with a high correlation
to the national economy occasionally follow their own economic
cycles, such as Arizona's real estate-induced slump in the late
1980s or California's extended recession in the early 1990s.
The five least populous states (ranked by their correlation to the
national economy), Idaho, Montana, Hawaii, Wyoming, and Alaska, are
not as closely linked to the national economy as more populous
states. These states are more likely to experience their own
upturns and downturns. Present conditions in these states do not
reflect the strong national economy; rather, their employment
growth ranges from weak compared with the nation (Idaho, Montana,
and Alaska) to little or no growth (Wyoming and Hawaii). These
five states are not closely linked to the national economy, so we
should examine other factors, like economic diversity and the
health of key industries, to understand their current economic
performance and their future prospects. Finally, since these states
often do not closely follow national economic trends, we might
expect that the performance of their community banks may not
closely follow U.S. banking industry performance either (see Regional Banking
Conditions).
The San Francisco Region Has a Diverse Economic
Base
A second key factor in explaining economic trends at the state
level is economic diversity. Diversity can be measured and used to
compare a state or region's industrial structure with that of the
nation. Diversity may help explain why some states are more likely
than others to follow national economic trends. Generally, we
expect states that are more diverse, or that have an industrial
composition more like the nation's, to move more closely with the
national economy.
A diversity index (Index) developed by the FDIC's Division of
Insurance is a useful tool for evaluating the diversity of a
state or region's economy compared with the nation. The Index is
derived from sectoral earnings data published by the Bureau of
Economic Analysis. It measures the differences between the share of
state-level earnings for key sectors of a state economy and the
share of earnings for those sectors at the national level. The
Index also takes into account the relative sizes of the various
sectors. Higher index values show greater diversity relative to the
national economy. A state or region that has the same share of
earnings for each sector of the economy as the nation will have the
maximum diversity rating, 100. A state with large differences in
industrial sectors from the national economy will have a low
diversity rating.
The diversity of the San Francisco Region's economy as a whole is
quite high. It ranked highest among all eight FDIC Regions in
diversity with a rating of 92, well above the average of 87 for all
the Regions. Even the Chicago Region, which has the lowest rating
(82), is relatively diverse compared with most states.
States Are Much Less Diverse than the Regions
State diversity index values or ratings vary much more widely than
do the ratings for the much larger FDIC Regions. The average index
value for all 50 states and the District of Columbia was just under
70 for 1996. Individual state diversity ratings ranged from 16 for
the District of Columbia, the least diverse area, to 93 for
Illinois, the most diverse. In the San Francisco Region, shown in
Chart 3, the range ran from 21 in Nevada to
90 in Utah, the fifth most diverse state economy in the nation.
Utah, California, and Arizona, with diversity index values ranging
between 86 and 90, are among the most diverse economies in the
nation. Furthermore, over the past 25 years both Utah's and
Arizona's economies have become significantly more diverse as these
states have expanded their service sector, increased their
manufacturing base, and reduced their dependence on natural
resource-based industries. In contrast, California's diversity
rating has not changed significantly in the past decade, despite
the ongoing restructuring in the state from defense-related
manufacturing toward services.
Three other states in the Region, Oregon, Washington, and Montana,
have diversity ratings around 70, close to the average rating for
all the states. The economies of these three states also have
become more diverse since the early 1970s, when all three were much
more dependent on natural resource-based industries. Of the three,
only Montana remains heavily dependent on natural resources. More
than 6 percent of Montana's 1996 earnings were generated from
agriculture, forestry, and extractive industries, more than double
the share for the nation.
Idaho, with a diversity rating of 60, and Hawaii, with a rating of
50, are less diverse than the typical state. Idaho's diversity
rating has improved in recent decades as the state has expanded its
manufacturing base and reduced its reliance on natural resources
and agriculture. Unlike Idaho, Hawaii's diversity rating has not
changed significantly from 25 years earlier. The lack of diversity
in Hawaii's economy results from the state's heavy dependence on
the tourist trade, which by some estimates accounts for
approximately one of every four jobs in the state.
The economies of Alaska and Wyoming, with Index ratings of 35 and
25, respectively, are among the least diverse of all the states.
These states rely heavily on natural resource-based industries like
oil and mining, and both have large governmental sectors
(accounting for over 25 percent of state employment, versus 16
percent for the nation). Furthermore, both states were less diverse
in 1996 than they were in the early 1970s. This trend runs counter
to the national trend toward greater diversity among states.
While Nevada's population doubled from 1979 to 1995, its economic
base has not become more diverse, and it continues to be the least
diverse of any state in the Region or the nation. Nevada is very
dependent on tourism, defined here to include gaming, lodging,
eating and drinking, air transport, and recreational employment.
These industries account for over one-third of all jobs in Nevada,
far above the national average. In addition, construction accounts
for almost 10 percent of all jobs, about twice the national
average.
Industrial Health Also Matters
The health of key industries is a third factor in a state's
economic well-being. Similar levels of economic diversity do not
necessarily translate into similar economic performance, because
the health of key industries or industrial sectors may vary from
state to state. For example, in 1997 two states with similar
diversity ratings, Washington and Montana, experienced vastly
different economic conditions. Fueled by an upswing in aerospace
manufacturing employment, Washington's economy is accelerating; it
is now one of the fastest-growing states in the nation. In
comparison, Montana's economy is slowing and lags behind the nation
in job growth. Montana has only a small manufacturing sector, and
its large mining sector is weak. The contrast between these two
states illustrates the important role the composition of a state's
economy can play in its health.
A comparison of Montana and Nevada further illustrates the
importance of key industries to a state's performance. They are the
only states in the Region where diversity was not consistent with
economic performance over the past year. Among the group of diverse
states, only Montana is lagging behind the nation in job growth. As
was noted earlier, it is heavily dependent on both the natural
resources sector and government jobs, two areas that have been weak
relative to the overall economy. In contrast, Nevada's economy is
the least diverse of all 50 states, yet it is booming. Nevada has
a heavy concentration in tourism and construction, industries that
have been expanding. Nevada's lack of diversity is presently a
factor in its rapid growth, again illustrating the importance of
the health of key industries at the state level.
Unlike larger interstate banks, community banks operating in state
or local markets will find their performance closely linked to
state or local market conditions. Thus, in states that are not
closely linked to the national economy, community bank performance
likely will reflect state and local economic conditions. The
situation in Hawaii illustrates this point. In spite of the
national recovery, Hawaii has been in a recession for several
years. Through the third quarter of 1997, Hawaii's community banks
(assets under $1 billion) recorded a year-to-date return on assets
(ROA) of only 0.81, well below the 1.35 ROA the Region's community
banks posted over the same period.
Implications: Correlation with the national economy, the
diversity of the industrial base, and the health of key industry
sectors provide useful information about this Region's state
economies. The economies of California, Washington, Arizona,
Oregon, Utah, and Nevada correlate much more closely with national
economic conditions than do those of the Region's less populous
states. Aside from Nevada, the Region's most populous states have
more diverse economies than the less populous states. In the event
of a national downturn, the historical record suggests that these
states likely would follow the national economy.
Diversity and industrial composition also are important for
analyzing a state's economic condition and potential risks.
Nevada's economy is the least diverse in the Region, yet it tends
to move closely in line with the national business cycle. Still,
Nevada faces an additional downside risk because its economy is
heavily concentrated in tourism and construction, two cyclical
sectors. A slowdown in the national economy, the state's huge
gaming industry, or its large gaming-dependent construction sector
probably would weaken Nevada's economy more than it would that of
other states. Moreover, this is an area of concern because
Nevada's booming economy has led to the formation of a number of
new banks, the rapid expansion of many smaller banks, and an
increase in community banks' exposure to construction and
commercial real estate lending.
Finally, Hawaii's ongoing recession illustrates the potential for
the Region's less populous states to follow their own business
cycles in spite of a strong national economy. Hawaii, Idaho,
Montana, Alaska, and Wyoming are less likely than the more populous
states to closely follow the national economy. These states either
rank low on diversity (Hawaii, Idaho, Alaska, and Wyoming) or are
relatively heavily dependent on natural resource-based industries
or agriculture, or both (Idaho, Alaska, Wyoming, and Montana).
An added risk in these states is that downturns are less likely
to coincide with a national recession than they are in the Region's
larger states. This fact may have implications for the banks in
these states, because a weak state economy normally will be
reflected in the performance of community banking institutions, as
currently is the case in Hawaii.
Gary C. Zimmerman
Regional Economist
Regional Outlook
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