Abstract: Introduction and summary Over the last 20 years, the U.S. banking industry has experienced significant structural changes as the result of an intense process of consolidation. From 1975 to 1997, the number of commercial banks decreased by about 35 percent, from 14,318 to 9,215. Since the early 1980s, there have been an average of more than 400 mergers per year (see Avery et al., 1997, and Simmons and Stavins, 1998). lhe relaxation of intrastate branching restrictions, effective to differing degrees in all states by 1992, and the passage in 1994 of the Ricgle-Neal Interstate Banking and Branching Efficiency Act, which allows bank holding companies to acquire banks in any state and, since June 1, 1997, to open interstate branches, is certainly accelerating the process of consolidation. These significant changes raise important policy concerns. On the one hand, one could argue that banks are merging to fully exploit potential economies of scale and/or scope. The possible improvements in efficiency may translate into welfare gains for the economy, to the extent that customers pay lower prices for banks' services or are able to obtain higher quality services or services that could not have been offered before.(1) On the other hand, from the point of view of public policy it is equally important to focus on the effect of this restructuring process on the competitive conditions of the banking industry. Do banks gain market power from merging? If so, they will be able to charge higher than competitive prices for their products, thus inflicting welfare costs that could more than offset any presumed benefit associated with mergers. In this article, I analyze competition in the banking industry, highlighting a very fundamental issue: How do we measure market power? Do regulators rely on accurate and effective procedures to evaluate the competitive effects of a merger? The U.S. Department of Justice, the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) enforce the antitrust laws in banking. The procedures to evaluate the competitive impact of a proposed merger may differ in some details among the agencies, but they all share the same approach, based on structural analysis of the banking market affected by the merger. The basic guideline, established by the Justice Department, requires the evaluation of the concentration of deposit market shares held by banks operating in the affected market. The importance of market concentration finds its theoretical justification in the so-called structure-conduct-performance paradigm (Bain, 1951), which postulates that fewer and larger firms (higher concentration) are more likely to engage in anticompetitive conduct. For example, a small number of large firms may be able to cooperate and act as a monopoly (cartel). Alternatively, one or more firms together may be large enough to set higher than competitive prices (acting as a dominant firm), while the other (smaller) firms would act as a competitive fringe, following the dominant firm's behavior. The most common measure of concentration, and the one used by regulators, is the Herfindahl-Hirschman Index (HHI), which is defined as the sum of the squared market shares of all banks in the market (box 1 explains how the index is calculated).(2) According to the current screening guidelines, if the postmerger market HHI is lower than 1,800 points, and the increase in the index from the pre-merger situation is less than 200 points, the merger is presumed to have no anticompetitive effects and is approved by the regulators. Should those threshold values be exceeded, the regulators will check for the existence of potential mitigating factors that would make it unlikely that the merger could result in anticompetitive behavior. The regulators also seek to identify those extreme cases in which the potential welfare loss from the exercise of market power would be smaller than the loss produced by maintaining the status quo (for example, the merger might prevent the failure of one of the parties involved, thus preserving the stability of the market). …

Abstract: Introduction and summary A companion article in this issue, "New facts in finance," summarizes the revolution in how financial economists view the world. Briefly, there are strategies that result in high average returns without large betas, that is, with no strong tendency for the strategy's returns to move up and down with the market as a whole. Multifactor models have supplanted the capital asset pricing model (CAPM) in describing these phenomena. Stock and bond returns, once thought to be independent over time, turn out to be predictable at long horizons. All of these phenomena seem to reflect a premium for holding macroeconomic risks associated with the business cycle and for holding assets that do poorly in times of financial distress. They also all reflect the information in prices - high prices lead to low returns and low prices lead to high returns. The world of investment opportunities has also changed. Where once an investor faced a fairly straightforward choice between managed mutual funds, index funds, and relatively expensive trading on his own account, now he must choose among a bewildering variety of fund styles (such as value, growth, small cap, balanced, income, global, emerging market, and convergence), as well as more complex claims of active fund managers with customized styles and strategies, and electronic trading via the Internet. (Msn.com's latest advertisement suggests that one should sign up in order to "check the hour's hottest stocks." Does a beleaguered investor really have to do that to earn a reasonable return?) The advertisements of investment advisory services make it seem important to tailor an investment portfolio from this bewildering set of choices to the particular circumstances, goals, and desires of each investor. What should an investor do? An important current of academic research investigates how portfolio theory should adapt to our new view of the financial world. In this article, I summarize this research and I distill its advice for investors. In particular, which of the bewildering new investment styles seem most promising? Should you attempt to time stock, bond, or foreign exchange markets, and if so how much? To what extent and how should an investment portfolio be tailored to your specific circumstances? Finally, what can we say about the future investment environment? What kind of products will be attractive to investors in the future, and how should public policy react to these financial innovations? I start by reviewing the traditional academic portfolio advice, which follows from the traditional view that the CAPM is roughly correct and that returns are not predictable over time. In that view, all investors (who do not have special information) should split their money between risk-free bonds and a broad-based passively managed index fund that approximates the "market portfolio." More risk-tolerant investors put more money into the stock fund, more risk averse investors put more money into the bond fund, and that is it. The new academic portfolio advice reacts to the new facts. An investor should hold, in addition to the market portfolio and risk-free bonds, a number of passively managed "style" funds that capture the broad (nondiversifiable) risks common to large numbers of investors. In addition to the overall level of risk aversion, his exposure to or aversion to the various additional risk factors matters as well. For example, an investor who owns a small steel company should shade his investments away from a steel industry portfolio, or cyclical stocks in general; a wealthy investor with no other business or labor income can afford to take on the "value" and other stocks that seem to offer a premium in return for potentially poor performance in times of financial distress. The stock market is a way of transferring risks; those exposed to risks can hedge them by proper investments, and those who are not exposed to risks can earn a premium by taking on risks that others do not wish to shoulder. …

Abstract: Introduction and summary The General Motors (GM) strike during June and July 1998 showed the extent to which lean manufacturing production methods, such as efforts to keep inventories low and reduce the number of parts suppliers, have taken hold in the U.S. auto sector. As observers tried to assess the ramifications of this event, it became apparent that we know much more about the spatial structure of light vehicle assembly operations and Big Three (Ford, GM, and Chrysler) owned parts plants than of the large number of independent parts suppliers. In an environment of tightly linked supply chains, it is important to understand the spatial nature of these linkages. Such knowledge would help policymakers assess the economic impact of regional shocks, such as a strike. In addition, data on individual customer-supplier linkages would facilitate the study of the geographic extension of supplier networks and offer new evidence on the ability of economic development efforts to attract suppliers to locate in the same state as a large assembly facility. Lean manufacturing was pioneered by Toyota Motor Company in Japan during the 1950s. It has since become the standard for many manufacturing companies in Japan and around the world. This production system tries to improve on the types of mass production systems that have been prominent in the postwar period. Instead of organizing production according to a preset schedule, it operates on the premise of a so-called pull system, whereby the flow of materials and products through the various stages of production is triggered by the customer. In addition, the production process itself is subject to continuous improvement efforts. The 1998 strike at two GM-owned parts plants in Flint, Michigan, was about issues related to production rates and health and safety. Strategically, however, it centered on issues pertinent to the implementation of new production methods - more efficient production processes that would reduce the demand for labor in the assembly plant and efforts by the assembly company to outsource more of the production of parts. The strike quickly shut down most of GM's North American assembly operation. In turn, it caused production adjustments at many of the company's independent suppliers. In this article, I examine the spatial structure of the auto supplier industry and how firms in different locations interact. First, I document the extent to which plants are concentrated geographically, that is, the degree of spatial agglomeration, in the U.S. auto supplier industry. My analysis is based on information on the location of over 3,000 auto supplier plants. I find that the auto supplier industry is concentrated in five states - Indiana, Kentucky, Michigan, Ohio, and Tennessee - that constitute the so-called auto corridor, which is defined by interstate highways 65 and 75, extending south from Michigan to Tennessee. These states are home to 58 percent of the plants in the study. A closer analysis of plant locations reveals the importance of access to highway transportation to ensure timely delivery of production to customers. I find that having suppliers located in the immediate vicinity of the assembly plant is not necessary to maintain a system of tight linkages and low inventories. Comparing the spatial structure of individual assembly networks, I find them to be remarkably similar. The geographic concentration is highest for assembly plants that are located near the heart of the auto corridor, with between 70 percent and 80 percent of supplier plants located within a day's drive of the assembly plant. This suggests a clustering of economic activity at the regional rather than local level. Second, I investigate the changing nature of the geographic concentration of this industry over time. This analysis is limited by the cross-sectional nature of the data. However, there are a few cases in which the data allow a comparison of supplier networks of different vintages. …

Abstract: Introduction and summary In January 1999, 11 European countries bravely launched into a common currency area known as the European Monetary Union (EMU). By joining the common currency area, member countries have agreed to keep the value of their national currency fixed in terms of the currencies of the other EMU countries for an indefinite period. Consumers and businesses in these countries will, however, find that very little has changed. The most noticeable change will not occur until 2002 when national currencies are replaced by a common currency known as the euro. In the intervening period, prices will be denominated in terms of existing national currencies and euros. Consumers using cash will pay the national currency price, while consumers using credit cards (including U.S. visitors to the euro zone) will notice that their transactions are carried out in euros. Although they might disagree about the exact size of the gains, most economists would agree that the EMU will yield significant microeconomic benefits through lower transactions and hedging costs. According to the European Commission, the gains from carrying out transactions in a single currency could be as high as 0.5 percent of European Union gross domestic product (GDP) per year. However, many economists are skeptical about the long-run viability of the EMU. Euro-zone members have given up the right to set their own interest rates and the option of moving their exchange rates against each other. The widespread view is that this loss of flexibility may involve significant costs (in the form of persistent high unemployment and low output growth) if their economies do not behave as one or cannot easily adjust in other ways. The ultimate concern is that for some countries, these macroeconomic costs will eventually outweigh the microeconomic benefits and lead them to abandon the EMU. How well the EMU performs along the macro dimension will depend on how closely it fits the notion of an "optimal currency area" (OCA). Beginning with Mundell (1961), economists have long agreed that the following four criteria must be met for a region to be an optimal currency area: 1) countries should be exposed to similar sources of disturbances (common shocks); 2) the relative importance of these common shocks should be similar (symmetric shocks); 3) countries should have similar responses to common shocks (symmetric responses); and 4) if countries are affected by country-specific sources of disturbance (idiosyncratic shocks), they need to be able to adjust quickly. The basic idea is that countries satisfying these criteria would have similar business cycles, so a common monetary policy response would be optimal. How far the euro zone is from an OCA is an open question for research, as is the more important question of whether the apparent deviation from an OCA is sufficient to question the long-run viability of the EMU. On the surface, the data seem to support the skeptics' view that the EMU is not an OCA. First, euro-zone countries have experienced frequent and often large idiosyncratic shocks over recent years. A well-known example is German reunification, which many argue led to the breakdown of the precursor to the EMU known as the European Monetary System (EMS) in 1992. [1] Second, persistently high unemployment rates throughout Europe suggest that EMU economies (especially their labor markets) are slow to adjust to all economic disturbances. The purpose of this article is to formally assess the long-run viability of the EMU. I do this by comparing the sources and responses to economic shocks to the EMU with those from a well-functioning currency union, the U.S. My working hypothesis is that if the EMU is as close to an OCA as the U.S. is, based on the criteria outlined above, it may well be a viable currency union in the long run. If, on the other hand, the EMU is less like an OCA than the U.S. is, one might question the long-run viability of this monetary union. …

Abstract: Introduction and summary Chicago is enlivened by the presence of many ethnic neighborhoods, which are reflected in the city's small business sector This makes Chicago an excellent location for studying small business finance in ethnic communities The topic is important because the availability of capital may depend, in part, on ethnic differences in factors such as the use of informal financing (loans or gifts from family, friends, or business associates) as opposed to formal financing from banks and other financial institutions We still have much to learn about business access to capital in an ethnic context To shed some light on these matters, the Federal Reserve Bank of Chicago and researchers from the University of Chicago conducted surveys in two Chicago neighborhoods, Little Village, a predominantly Hispanic community, and Chatham, a predominantly Black community These communities were chosen because they are distinct and well-recognized ethnic neighborhoods with viable small business sectors Although most of the business owners interviewed are either Black or Hispanic, other ethnic groups are represented One of the important features of the surveys is that they shed light on informal and formal sources of financing for both households and businesses Small business access to capital is an important policy issue because business owners may face funding limits, known to economists as liquidity constraints Although many observers might take funding limits as self evident, studies have shown that liquidity constraints affect entrepreneurs both upon start-up and after the business is underway(1) These constraints deter entry into self-employment and force would-be owners to save for longer periods before launching a business The effects of start-up constraints extend to ongoing businesses, because starting with more capital increases an owner's prospects of developing a viable, growing business(2) Thus, entrepreneurs' ultimate success depends, in part, on how successful they are in obtaining adequate capital and credit Loan guarantees and other programs offered by the US Small Business Administration are examples of government policies aimed at increasing access to credit for small businesses Considering access to capital and credit across neighborhoods and across ethnic and racial groups raises other policy issues Owning a successful business builds personal wealth, and self-employment historically has been an important means for raising the economic status of some ethnic groups Promoting the success of small business is an important part of community economic development strategies, particularly for minority neighborhoods that have suffered from a lack of investment in the past The purpose of the Community Reinvestment Act is to encourage depository institutions to help meet the credit needs of the communities in which they operate, consistent with sound banking practices While racial discrimination in residential mortgage markets has been the subject of a number of empirical studies, the effect of racial discrimination on access to capital for minority business owners and neighborhoods has received little attention to date from researchers(3) In practice, owners meet the challenge of obtaining capital to start and run their businesses by using informal sources, as well as personal assets and loans from formal sources Thus, informal financing via networks can substitute for borrowing in the formal sector, either because formal credit is not offered or because informal financing is preferred Credit offered by a supplier, or trade credit, is another alternative to borrowing from financial institutions Businesses form networks with their suppliers, and there may be an ethnic dimension to these networks, in that the ethnicity of the supplier may matter for some transactions The main contribution of this article is to provide information about the use of formal and informal sources of financing …

Abstract: Introduction and summary The purpose of this article is to study the sources of regional employment fluctuations in the U.S. and to shed light on the interactions of these regional fluctuations with the aggregate economy. Many studies of regional employment growth have analyzed the effect of regional differences in a number of underlying factors, such as local government expenditures and tax policy, while controlling for aggregate economic activity. My analysis focuses alternatively on the role of regional fluctuations in determining aggregate economic activity. Macroeconomists have tended to concentrate on the impact of changes in aggregate factors in determining the business cycle. [1] Such aggregate factors have included, for example, fiscal and monetary policy, the role of consumer confidence, aggregate supply and demand, and productivity. Yet there is a growing literature that suggests that aggregate disturbances are the result of a variety of influences. [2] In the work introduced here, I explicitly consider the role of regional employment fluctuations in determining the business cycle. I do not specifically identify the sources of such regional shocks. They could be the result of changing federal governmental policies, for example, immigration or defense spending, that impinge upon certain areas of the country more than others. They could also reflect changes in local welfare programs or shifts in local fiscal and tax policy. The analysis is complicated by the fact that while regional fluctuations may have aggregate repercussions, aggregate factors influence regional growth as well. For example, general productivity shocks are likely to have broad consequences across a variety of industries and geographical areas that are reflected in regional employment growth. Ascertaining what movements in employment growth are common across regions and what are region-specific would be helpful for policymakers. If, for example, regional employment growth is largely unrelated to employment growth in other regions, a more regional policy focus might be appropriate. Examples of more localized policy would include differential taxation and spending programs that are coordinated within a region or a more geographically targeted approach to federal government spending. If, however, most regional employment growth is common across regions, a more centralized policy process is warranted. The business cycle has been conceptualized as "expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle." [3] Thus, the business cycle is characterized by comovements among a variety of economic variables and is observable only indirectly. Only by monitoring the behavior of many economic variables simultaneously can one quantify the business cycle. For example, recessions are typically associated with declining output and employment across broadly defined industries. It is this notion of comovement that has supplied the foundation for measuring cyclical activity. This is the practice behind the widely publicized National Bureau of Economic Research's (NBER) dating of business cycles and Stock and Watson's (1988) index of coincident economic indicators. While most analyses of the business cycle focus on the notion of comovement in employment or output across industries, a great deal of comovement exists across geographical regions as well. Yet, until recently this regional cyclicality has gone largely unexplored, with a few notable exceptions such as Altonji and Ham (1990), Blanchard and Katz (1992), Clark (1998), and Clark and Shin (1999). The reason for the lack of interest in the regional cycle has largely been the belief that whatever cyclicality a geographical region experiences is due in large part to its industrial mix and to common aggregate shocks. In fact, regional shocks are typically not considered in assessing the business cycle. …

Abstract: Introduction and summary The Consumer Price Index (CPI) is widely used as a measure of inflation. However, there is a growing consensus that the CPI substantially overstates changes in the true cost of living. Table 1 summarizes recent studies on upward bias in the CPI of major industrial countries; the effect of this upward bias ranges from 0.5 percentage points to 1.1 percentage points per year. In the case of Japan, the effect is estimated at 0.9 percentage points per year. Upward bias in the CPI arises because the current CPI fails to account for the dynamic nature of economic activity, such as changes in consumers' behavior in response to relative price fluctuations between goods, the introduction of new goods, and the disappearance of old goods. Upward bias in the CPI has a direct implication for monetary policymakers, whose major mandate is to maintain price stability. Although biases in inflation measures do not matter when inflation is high, they do matter when policymakers are considering whether to bring down an already low inflation rate. In this sense, as economies approach price stability, accurate measurement of inflation is especially challenging. The importance of accurate price measurement is apparent in a country like Japan where there is controversy as to whether the country is on the verge of deflation.(1) Without upward bias, the Japanese CPI would have shown even stronger evidence of deflation in recent years. Moreover, accurate price measures are necessary to interpret economic developments, not only involving inflation but also real output and productivity. If measured inflation is rising more rapidly than actual inflation, measured real economic growth is simultaneously being understated. This implies that real incomes and living standards are rising faster than the published data suggest. In addition, the overstatement of inflation creates an automatic and unintended real increase in social security and other indexed federal benefits and a real cut in indexed individual income taxes each year.(2) In examining the problems of price measurement, a distinction must be made between the measurement of individual prices and the aggregation of those prices into the overall price index. Aggregation may introduce biases, because the CPI assumes that households purchase the same basket of goods and services over time, although, in reality, they substitute some goods for others as relative prices change and new goods are introduced. However, the problems of aggregation are well understood by economists, and workable solutions are within reach.(3) The most important remaining problems relate to the measurement of individual prices. Observing and measuring individual prices is quite difficult both conceptually and practically. This is because it is very hard to divide the nominal value of a good into quantity and price on a quality-adjusted basis. As the characteristics of products and services are changing rapidly, it is becoming increasingly difficult to define the unit of output and adjust an item's price for improvements in quality. These problems are pervasive in modern economies. For example, automobiles, refrigerators, TV sets, VCRs, camcorders, personal computers, winter jackets, and sports shoes have all changed in ways that make them surprisingly hard to compare with their counterparts in the past. Indeed, as shown in table 1, quality change/new product bias is identified as the largest source of upward bias in the CPI in major industrial countries. [TABULAR DATA FOR TABLE 1 OMITTED] In this article, I investigate the problems inherent to the quality changes/new goods bias in the CPI, taking the Japanese case as an example. I review the sources of measurement errors in the CPI and examine the problems inherent in the methodology used for quality adjustment in the Japanese CPI. I describe the basic framework of the hedonic approach (methodology to analyze the price-quality relationship by regressing prices on numerous characteristics of a product) and propose a practical way to improve the accuracy of quality adjustment by introducing this approach to the conventional procedure to compile the CPI. …

Abstract: Introduction and summary The U.S. economy is booming, with 30-year lows in the unemployment rate, historical highs in labor force participation, and the lowest displacement rates (a measure of the incidence of involuntary job loss) in a decade. Displacement rates are especially low among groups, such as blue-collar workers, that have traditionally been most vulnerable to displacement. However, many groups may still be feeling the bite of the drawn-out corporate restructuring of the early- and mid-1990s. For example, The Wall Street Journal recently described the difficulty experienced by some older professional workers in finding new employment following the mass layoffs of the early 1990s (Horwitz, 1998). Recent studies document trends in job displacement ratios and related anxiety among workers with at least five years of job tenure (Aaronson and Sullivan, 1998a, b). Like other work that analyzes job displacement, these studies focus more on the demographic determinants and consequences of displacement than on the fundamental causes of layoffs. Yet very little is known about the causes of displacement, particularly the roles of technological change, increased foreign competition, changes in domestic demand, low productivity within an otherwise growing sector of the economy, poor management, regulatory changes, or regional or national recession (Kletzer, 1998). Understanding the causes of displacement is important for policymakers charged with designing job search assistance, retraining, relocation allowances, and other programs to aid displaced workers. For example, a stronger case for training subsidies could be made for workers who are displaced due to technological reasons. Although research on the benefits of government training finds little return to such programs (relative to their cost), it is possible that the impact is more significant for workers displaced because of technology.(1) At a minimum, a relationship between displacement and technology contributes to a vast literature that shows the importance of education and training throughout a person's career. Furthermore, the relationship between technology and displacement is important in understanding government's role in restricting natural job flows, say through the imposition of policies such as mandated severance packages in Europe intended to provide higher job security. In a technologically dynamic environment, labor markets need to be able to react to shifts in industry skill demands. While a case could be made for job security provisions if job destruction were due to poor management, unnecessarily constraining labor mobility in technologically innovative industries is likely to curtail long-run employment growth (Bentolila and Bertola, 1990). In this article, we seek to fill a gap in the displacement literature by exploring the implications of technological change for job displacement and reemployment. We describe some reasons technological innovation might affect displacement and argue that the labor market status of less skilled and older workers might be particularly influenced by technology. We use several different datasets, including the Bureau of Labor Statistics' Displaced Worker Survey (DWS), to test whether high-tech sectors are more likely to displace workers and, conditional on such displacement, whether these workers find it more difficult than their peers in low-tech industries to reenter the labor market. Our results provide evidence that industry-specific technological innovation affects the probability of displacement and reemployment. However, many of the results are not robust to the particular measure, or proxy, of technology used. This is not surprising since our technology proxies are from five different data sources, often do not cover the same industries, and cover a variety of topics, including computer usage, computer investment, productivity growth, and research and development (R&D) activity. …

Abstract: Introduction and summary Two central concerns of economic policy are growth and business cycle stabilization. There is considerable interest in devising government policies and institutions to influence prospects for economic growth and mitigate the distress associated with economic downturns. Proper evaluation of the benefits and costs of a given policy proposal requires knowledge of the determinants of growth and business cycles. This is one reason for the considerable body of research aimed at understanding these phenomena. The last two decades have seen considerable advances in this research. Recent empirical evidence, however, brings into question two of its basic assumptions-first, that technological change is homogeneous in nature, in that it affects our ability to produce all goods symmetrically, including consumption and investment goods; and second, that business cycles are driven by shocks which affect the demand for investment goods. In this article, I document the key evidence that challenges the conventional views of growth and business cycles. I then discuss the plausibility of alternative theories that have been advanced to meet the challenge. To date, the evidence seems to support a new view of growth and business cycles, one that is based on technical change biased toward new investment goods like capital equipment. The key evidence involves two observations on the behavior of the relative price of business equipment over the last 40 years. First, in almost every year since the end of the 1950s, business equipment has become cheaper than the previous year in terms of its value in consumption goods. This means that if one had to trade restaurant meals for a piece of equipment that makes the same number and quality of, say, bicycles, one would forgo fewer meals in 1998 than in 1958. Second, this relative price tends to fall the most when the economy, and investment expenditures in particular, are growing at relatively high rates, that is, it is countercyclical. The first piece of evidence is striking because it suggests that much of post-WWII economic growth can be attributed to technological change embodied in new capital equipment. This conflicts with conventional views on what drives economic growth. A piece of capital equipment is a good that is used to produce another good, such as a crane or a computer. An improvement in capital-embodied technology is the invention of equipment that takes the same amount of labor and preexisting equipment to produce as the old equipment but that produces more goods when combined with the same amount of labor as before. If a new production process yields the same units of capital equipment with less factor inputs, then this has the same economic implications as if the capital equipment produced were itself more efficient. Hence, an equivalent interpretation of what constitutes capital-embodied technical change is that it involves an improvement in the technology that produces capital equipment. To understand the relationship between capital-embodied technical change and the trend in the equipment price, suppose the technology for producing consumption goods is fixed. With improvements in technology embodied in equipment, the supply of (quality-adjusted) investment goods increases relative to consumption goods, so the equipment price falls. Greenwood et al. (1997) build on this insight to show that a large ffaction of economic growth can be attributed to capital-emhodied technical change. This conflicts with the conventional view that most growth is due to disembodied technical change, or multifactor productivity. Improvements in disembodied technology, usually measured as the Solow (1957) residual, make it possible to produce all kinds of goods, not just capital goods, with less capital and labor.(1) If this were the dominant source of growth, then we should not have seen such a large drop in the price of equipment over the last 40 years. …

Abstract: Introduction and summary A proposal to amend the U.S. Constitution to require that the federal budget be balanced has been a part of the national debate for over 25 years. Following its inclusion as one of the central planks of the Republican Contract with America in 1994, the balanced budget amendment became a prominent item on the congressional agenda. The amendment easily passed the House by a vote of 300 to 132 in January 1995, but failed to achieve the two-thirds majority required in the Senate to send it back to the states. Since the proposal's most recent failure in the Senate, by one vote on March 4, 1997, it has been a less important agenda item because of the strength of the economy and the surplus in the federal budget. However, the issue is by no means dead. In January 1999, the amendment was again proposed in the House with the cosponsorship of 117 representatives. Balanced budget amendment supporters frequently cite the experience of the states, most of which have statutory or constitutional balanced budget restrictions.(1) In this article, I question how the state experience with balanced budget restrictions can inform the federal debate on a balanced budget amendment. First, I address how the longstanding state restrictions compare with those contemplated at the federal level. I then investigate how state government revenues, expenditures, debt issuance, and asset holdings have responded to changes in the states' economic conditions, as measured by the unemployment rate, during the last two decades. I use regression analysis to ask how, controlling for a time trend and state fixed effects, state finances have reacted to fiscal year state unemployment rates from 1977 to 1997. I further question whether similar responses on the part of the federal government would be either feasible or prudent. In my investigation of how state finances respond to business cycle conditions, I discover that states use four main mechanisms to maintain budget balances during downturns: they issue more short- and long-term debt; they rely more heavily on the federal government for funds while giving less to local governments; they increase tax rates; and they lower capital spending. This is not a feasible policy combination for the federal government for a number of reasons. Most importantly, the provisions of the balanced budget amendment would not allow the federal government to issue any new debt without a legislative super-majority. In this way, the federal balanced budget amendment differs significantly from the restrictions in place in the states. While the states use the issuance of debt as an important safety valve, this option would not be available to the federal government. Of course, the opportunity to receive more from a higher level of government would also not be available to the federal government. However, the federal government could follow the states' lead by transferring less money to the states during difficult times. This would reverse the current relationship between federal government intergovernmental spending and the business cycle and would make it more difficult for the state governments to balance their budgets. Importantly, this suggests that one of the reasons that the states are able to balance their budgets is that the federal government does not. The federal government could follow the states by increasing tax rates during economic downturns. This would be an unpopular policy for two main reasons. First, tax increases are always unpopular and difficult to pass. Second, unlike the state governments, the federal government is responsible for the condition of the macroeconomy. Tax increases during recessions would further depress disposable incomes and consumption and could prolong downturns. The other state behavior open to the federal government would be to decrease capital spending during economic downturns. States get a lot of leverage out of their ability to cut capital spending during difficult times; my results show that this is among the most pronounced state responses to a deteriorating economic situation. …

Abstract: Introduction and summary During the mid-1980s, demographers and work force analysts began forecasting slower work force growth and tighter labor markets as the last of the so-called baby boomers entered the work force and rising female work force participation began to level off (Johnston and Packer, 1987). Employers were warned that the shrinking pool of new workers, along with their increasing diversity, would present new challenges in obtaining and managing a productive work force. In the Midwest, such concerns seemed very remote. Throughout much of the 1970s, 1980s, and very early 1990s, employment demand was weak and migration of workers from the Midwest was the norm. In the late 1990s, however, labor market conditions have changed significantly. Currently 3.0 percent, Midwest unemployment has consistently ranged between 0.5 and 1 percentage point below the national average over the last five years. And many business executives in the Midwest report "finding good help at current wage offers" as the most vexing of current problems (Bank of America, 1998). In this article, we examine whether the current tight labor markets in the Midwest are likely to continue. We conclude that, although a part of this labor market tightness is transitory, the Midwest will experience slower work force growth accompanied by continued strong demand for workers.(1) After a severe shock in the early 1980s, the region's mainstay industries have restructured and found ways to compete. Auto and truck production have reconcentrated in the mid-section of the nation due to a complementarity between the industry's new emphasis on just-in-time delivery and the region's advantageous location and dense highway infrastructure. Supply-side limitations also suggest labor market tightness will continue. The region's robust work force growth of the past ten years has come about, to a significant extent, through reemployment of an underemployed population rather than new workers. Net migration of workers from other regions and other countries does not appear to be as significant in the Midwest as in many regions of the South and West. Meanwhile, like other regions, the Midwest is expected to continue to experience a tepid pace of entry of young adults into the work force. What are the implications of ongoing labor market tightness for the region's businesses and policymakers? Because tight labor markets bring both benefits and costs, policy initiatives to stimulate work force growth will not be uniformly favored. For example, while business and property owners might favor policy actions to encourage workers to migrate to the region, such measures might adversely affect Midwest workers by putting downward pressure on wages. On the other hand, workers have much to gain from tight labor markets - rising real wages and incomes and better job opportunities. Despite these reservations about expanding labor supply, work force growth can benefit indigenous workers, particularly in areas where population growth may be needed to sustain declining towns, cities, and industries. In addition, incoming workers with specific skills may help generate demand for groups of indigenous workers with related or complementary skills who may be underemployed. Policies to ease labor-constrained growth by expanding the skills and education of the region's existing population may be less contentious than those aimed at boosting migration. Such policies are also more likely to raise wages and per capita incomes on a sustained basis, because they are based on improvements in worker productivity. Labor market participation rates may also be increased through improvements in transportation between inner cities and suburbs offering new job opportunities and other programs that facilitate the entry of low-income groups into the work force. Midwest labor market tightness: A transitory problem? Now into its ninth year of expansion, the U.S. economy is enjoying the longest run of uninterrupted growth in modern history. …

Abstract: Introduction and summary Women's labor force participation has nearly doubled over the last 50 years, from 31.0 percent in January 1948 to 60.6 percent by March 1999 (based on monthly data from the Current Population Survey). For women with young children, the increases have been even more dramatic. From 1947 to 1996, the labor force participation rate of women with preschool-aged children increased by more than a factor of five, rising from 12.0 percent to 62.3 percent (U.S. House of Representatives, 1998). The rapid increase in participation of women with young children indicates that women are spending less time out of the labor force for child bearing and rearing. Indeed, looking at new mothers in the National Longitudinal Survey of Youth (NLSY), of those who were working prior to the birth of their first child, three-quarters were back at work within a year of the birth. An important consequence of the trend toward more rapid reemployment of new mothers is that recent generations of women will have more actual labor market experience (at each age) than their predecessors. [1] In labor economics, a standard analysis of the relationship between wages and education and age (reflecting potential experience) shows that wages increase with years of potential experience. For women, potential experience is likely to exceed actual experience by more than for men. Thus, the increase in women's actual work experience should be reflected in a narrowing of the gender earnings gap. In fact, despite the growing wage inequality of the 1980s, the male-female earnings gap has been closing steadily since the late 1970s. From 1978 to 1990, the ratio of female to male earnings rose from 0.73 to 0.85 for whites and from 0.60 to 0.70 for African-Americans. [2] According to O'Neill and Polachek (1993), about one-quarter of the closing of the male-female wage gap over the 1976-87 period can be attrib uted to changes in the actual labor force experience of women and an additional 50 percent can be accounted for by changes in returns to experience for women relative to men. Realistically, working women who choose to have children will have to take some time off of work either by taking family, sick, or vacation leave or by exiting the labor market entirely. However, given the importance of experience in determining wages, the faster women return to work following childbirth, the closer their actual experience will be to their potential experience and the smaller the average earnings penalty for women who have children. In this article, I examine the economic determinants of a woman's decision to return to work quickly following childbirth. I consider three key factors in this decision: the opportunity cost of taking time out of the labor force (that is, the potential wage rate available to a woman), the wealth effect of other family income, and most particularly, the opportunity cost of working outside the home in terms of child care costs. I first describe a simple theoretical model of a new mother's return-to-work decision. The model predicts that the decision to return to work will depend on a woman's wage net of hourly child care costs and other family income (including spouse or partner income). I then test the theoretical model as closely as possible. In order to get a measure of child care costs faced by women as they decide whether to return to work, I calculate average child care worker wages across states and over time to proxy for variation in child care cost across states and over time. I find that women with higher wages are significantly more likely to return to work, and women facing higher child care costs or having greater other family income are significantly less likely to return to work after first birth. I also find that older women, women with more education, and women whose adult female role model was working when they were teenagers are more likely to return to work. Additional interest in women's labor force participation has been generated by the reforms to welfare programs that have a primary goal of getting recipients off of welfare and into the work force. …

Abstract: Introduction and summary Thousands of new commercial banks have been chartered in the U.S. over the past two decades. As the U.S. banking industry continues to consolidate, these de novo banks are potentially important for preserving competition and providing credit in local markets. However, like other new business ventures, newly chartered banks initially struggle to earn profits, and this financial fragility makes them especially prone to failure. In this article, I document the financial evolution of the typical de novo bank and develop and test a simple theory of why and when new banks fail. Recent decades have seen an upsurge in the number of mergers and failures among new banks. Figure 1, panel A shows the annual change in the number of commercial bank charters in the U.S. since 1966. Prior to 1980, the reduction in bank charters due to mergers and failures was relatively stable at about 100 charters per year, or about 1 percent of the industry total ([ILLUSTRATION FOR FIGURE 1 OMITTED], panel B). The pace accelerated greatly after 1980, and since 1986 about 600 charters, or 5 percent to 6 percent of the industry total, have disappeared each year due to mergers and failures. To a large extent, this tremendous consolidation can be explained by the repeal of federal and state laws that restricted branch banking and interstate banking. As these restrictions gradually were relaxed, banking companies expanded their geographic reach by acquiring thousands of other banks, and reduced their overhead expenses by converting thousands of affiliate banks into branch offices. This geographic expansion, combined with newly deregulated deposit rates, increased competition between commercial banks just when new information technology was allowing mutual funds, insurance companies, and the commercial paper market to compete for banks' traditional loan and deposit businesses. Under these new competitive conditions, many commercial banks became more vulnerable to economic downturns, and thousands of banks failed during the 1980s and early 1990s. Over the past two decades, the combined effect of these mergers and failures has reduced the number of commercial banks in the U.S. by nearly 40 percent. This consolidation has been partially offset by a recurring wave of new bank charters. As shown in figure 1, panel A, over 3,000 de novo commercial banks have been chartered by state and federal banking authorities since 1980. It is generally believed that these newly chartered banks can help restore competition in local markets that have experienced a large amount of consolidation. It is also commonly believed that these newly chartered banks can help replace credit relationships for small businesses whose banks failed or were acquired or reorganized. However, before a newly chartered bank can provide strong competition for established banks and before it can be a dependable source of credit for small businesses, it must survive long enough to become financially viable. I begin by examining the conditions under which investors are likely to start up new banks, including the influence of business cycles, merger activity in local banking markets, and the policies of federal and state chartering authorities. Next, I track the evolution of profits, growth rates, capital levels, asset quality, overhead costs, and funding mix at more than 1,500 commercial banks chartered between 1980 and 1994. These data suggest that newly chartered banks pass through a period of financial fragility during which they are more vulnerable to failure than established banks. Specifically, new bank capital ratios quickly decline to established bank levels, but new bank profits improve more slowly over time before attaining established bank levels. Based on these empirical observations, I develop a simple life-cycle theory of de novo bank failure, in which the probability of failure at first rises, and then declines with the age of the new bank. …