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Home > Industry Analysis > Research & Analysis > San Francisco Regional Outlook - First Quarter 1998

San Francisco Regional Outlook - First Quarter 1998

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.

Chart 1

Chart 2

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.

Chart 3

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

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Last Updated 7/27/1999

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