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Southwest Economy - Federal Reserve Bank of Dallas

VIEWS: 1 PAGES: 12

									   FEDERAL RESERVE BANK OF DALLAS                                       Issue 2 March /April 2001




Southwest Economy                                   .....................
                                                    Texas Economy Cools in 2000
                                                         The Texas economy has known nothing but
                                                    growth for more than a decade now. Steady
                                                    employment gains and an increasingly diverse
                                                    marketplace have been the hallmarks of this ex-
                                                    pansion. After 13 years of positive job growth,
                                                    Texas came through once again. The Lone Star
                                                    State added over 338,000 jobs last year despite a
                                                    sizable falloff of domestic activity in the closing
                                                    months of 2000.
                                                         However, Texas did not escape the economic
                                                    softening in 2000 unscathed. Every sector except
                                                    finance, insurance and real estate (FIRE) saw
                                                    weakened employment growth during the second
                                                    half. And statewide nonfarm employment growth
                                                    waned from 5.1 percent in the first quarter to 2.8
                                                    percent in the fourth (Chart 1 ).1
                                                         Several factors curbed the rate of economic
                                                    growth during the latter half of 2000. Higher inter-
                                                    est rates and weakened U.S. and world economies
                                                    negatively affected the Texas business environ-
                                                    ment. Excess capacity and increased input costs
                                                    hurt the chemical and refining sector, and high
                                                    technology suffered as sales of computers, semi-
                                                    conductors and telecommunications equipment
                                                    ebbed from high levels.2
                                                         Consumer confidence took several hits toward
                                                                                (Continued on page 2)

                   ...................
                       Bank Competition in the New Economy
                              Numerous economic forces, including technological innovations and pru-
                         dent monetary and fiscal policy, account for the unprecedented growth and
                         prosperity experienced over the past decade. However, an important, and
                         often overlooked, factor is the relative stability and health of the banking
                         system. A healthy, vibrant banking sector helps ensure that financial capital
   INSIDE:               is directed to those businesses that would benefit most, thereby enhancing
 Why Free Trade          the nation’s economic well-being.
                              Although the banking system has not experienced major problems over
in the Americas?         the past decade, it has undergone substantial changes; in particular, its market
                         structure has been evolving. This evolution is due primarily to two factors:
                         (1) financial deregulation, in particular the repeal of restrictive laws; and
                         (2) technological innovations related to computers and the Internet. Both fac-
                         tors have the potential to produce long-lasting effects on market structure not
                                                                                 (Continued on page 6)
      Chart 1                                                                                                                                                drilling rigs continued to rise, exceeding
                                                                                                                                                             400 by year-end.
      Texas Job Growth in 2000                                                                                                                                    Energy companies had a heyday in
      Percent change, annualized                                                                                                                             2000. Many oil firms, including Irving-
      9                                                                                                                                                      based Exxon Mobil Corp., realized
                                                                                January–June           July–December
      8                                                                                                                                                      record fourth-quarter profits. With an
                                                                                                                                                             increase of 124 percent over 1999, the
      7
                                                                                                                                                             firm’s 2000 net income gain was the
      6                                                                                                                                                      largest ever recorded by a U.S. corpora-
      5
                                                                                                                                    Q1                       tion.3 Such improvements did not go
                                                                                                                                                             unnoticed on Wall Street; energy sector
      4                                                                                                                                  Q2
                                                                                                                                              Q3
                                                                                                                                                             investments garnered 10.2 percent in
      3                                                                                                                                                      aggregated returns during 2000.4
                                                                                                                                                   Q4
      2
                                                                                                                                                                  Only 5.2 percent of Texas GSP
                                                                                                                                                             comes from the oil and gas industry
      1                                                                                                                                                      (down from about 20 percent in the
      0                                                                                                                                                      early 1980s), but high prices improved
            Construction        Mining            TCPU         Manufacturing        Services          Trade            FIRE        Total nonfarm
                                                                                                                                                             the financial viability of many energy
      NOTE: TCPU is transportation, communications and public utilities; FIRE is finance, insurance and real estate.
      SOURCES: Bureau of Labor Statistics; Federal Reserve Bank of Dallas.
                                                                                                                                                             firms and helped buttress the economy
                                                                                                                                                             against slowing in other sectors. There
                                                                                                                                                             was a downside, however; elevated oil
                                                                                                                                                             and gas prices boosted production costs
                                                                                                                                                             for chemical-manufacturing firms, pun-
    the end of the year as households began                                      employment rate remained in check at                                        ishing earnings.
    to internalize the effects of weakened                                       3.7 percent.
    investment portfolios and diminished                                                                                                                     Exports and Mexico
    equity values. Spending on consumer                                          Energy                                                                           Texas trade conditions continued
    goods fluctuated as the so-called wealth                                         Fervent world demand and OPEC                                           very strong in 2000. Total exports during
    effect adjustment began to work its way                                      production controls combined to send                                        the first three quarters exceeded $78
    through the Texas economy.                                                   energy prices through the roof in 2000.                                     billion, a 24.7 percent increase over the
         Despite second-half weakening, Texas                                    Oil prices tripled from 1998 levels, and                                    same period in 1999 and the largest
    fared well overall. Annual employment                                        natural gas prices quadrupled from 1999.                                    percentage gain since 1987. Texas ex-
    growth registered a lofty 3.7 percent gain                                   The industry woke up to the high prices:                                    ports accounted for 13.4 percent of
    in 2000, easily surpassing the national                                      Texas oil and gas employment grew 3.6                                       total U.S. exports in 2000 (second only
    figure of 1.6 percent. While high energy                                     percent (4,900 jobs) on the year. Addi-                                     to California’s 15.2 percent share). Put a
    prices are generally unfavorable to the                                      tionally, the number of oil and gas                                         different way, over $1 in every $8 of
    U.S. business climate, they continue to
    be a positive force for Texas by helping
    pump up cash flows and employment
    for oil and gas companies. Texas exports                                          Chart 2
    to Mexico, which make up about half the
                                                                                      Texas Employment in Selected Sectors
    total, surged nearly 31 percent in the first
                                                                                      Index, January 1998 = 100
    three quarters over the same period in
                                                                                       125
    1999. Texas exports to Asia improved
    dramatically over 1999, increasing more                                            120                                                                                      Construction
    than 50 percent in the first three quarters
    of 2000.                                                                           115

         The construction sector added                                                                                                                                          Service-producing
                                                                                       110
    30,000 jobs in 2000, and the value of res-                                                                                                                                  Total

    idential building contracts increased 14.7
                                                                                       105
    percent (Chart 2 ). Even manufacturing
    employment, which has been anemic                                                  100
                                                                                                                                                                                Manufacturing
    for three years, edged higher by 14,700
    jobs (1.4 percent)—a good showing                                                   95

    for an industry that lost 178,000 jobs
                                                                                        90
    nationwide. Gross state product (GSP)                                                                  1998                               1999                  2000                       2001
    increased 2.7 percent in the first three                                          SOURCES: Bureau of Labor Statistics; Federal Reserve Bank of Dallas.
    quarters of 2000, and the December un-


2                                                         FEDERAL RESERVE BANK OF DALLAS SOUTHWEST ECONOMY MARCH /APRIL 2001
  Chart 3                                                                                                                                 tributed to slowing in the Texas tech-
                                                                                                                                          nology sector.
  Texas Exports by Region                                                                                                                      Initially, stock values took the brunt
  Real seasonally adjusted index, 1997:1 = 100                                                                                            of the blow, but by midyear the damage
  205
                         Other                                                                                                            had bled over into employment levels as
                         13%                                                                                                              well. The stock market served the sector
  185
                                            Mexico
                                                                                                                                          a severe comeuppance in March and
                  Asia                                                                                                         Mexico
  165
                  19%                        46%                                                                                          April, and many firms saw their equity
                                                                                                                               Asia       values plummet. By year-end, aggregate
                Euroland
  145             7% Latin                                                                                                     Total      returns for technology-based portfolios
                      America Canada                                                                                           Euroland   were all in the red. Nationwide, semi-
                         5%    10%
                                                                                                                               Canada
  125                                                                                                                                     conductors were down 19.8 percent,
                                                                                                                                          telecom 33.1 percent, and online retail
  105                                                                                                                    Latin America
                                                                                                                                          and information 47.3 percent and 54.1
                                                                                                                               Other
   85
                                                                                                                                          percent, respectively.8
                                                                                                                                               Texas employment in durable manu-
   65                                                                                                                                     facturing (which includes high tech)
                     1997                             1998                            1999                             2000
                                                                                                                                          started the year out strong, increasing
  NOTES: Euroland comprises Denmark, Switzerland, Greece, Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg,
         Netherlands, Portugal and Spain. Latin America comprises Argentina, Brazil, Colombia and Venezuela. Asia comprises China, Hong   4.9 percent in the first three months. But
         Kong, Indonesia, Japan, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand.                                            subsequent quarters exhibited steady de-
  SOURCE: Massachusetts Institute for Social and Economic Research.
                                                                                                                                          clines in the growth rate; by the fourth
                                                                                                                                          quarter, job growth had slowed to 1.1
                                                                                                                                          percent.

goods shipped from U.S. ports came                                        jobs) from January through October.                             Metropolitan Areas
from Texas.                                                               Trade with Mexican companies contin-                                 Texas is a summation of its parts;
     Export trade makes up 14 percent of                                  ued to revitalize Texas’ border cities. In                      five major metropolitan areas make up
Texas’ total economic output. The state                                   fact, 90 percent of El Paso’s exports went                      almost 70 percent of the state’s total
ranks third in per capita exports, behind                                 to the maquiladoras in 2000. The value                          employment. Job growth was positive
Vermont and Washington. Three indus-                                      of total trade activity was $35 billion                         in every major area in Texas in 2000
tries made up the lion’s share of Texas                                   for Laredo, $16 billion for El Paso and                         (Charts 4 and 5 ). Here’s how each metro
exports in 2000: electronics accounted                                    $5.7 billion apiece for Brownsville and                         area fared for the year.
for 26.8 percent of the total; industrial                                 Hidalgo.6                                                            Austin. Predictions that Austin’s super-
equipment (including computers), 17.6                                                                                                     tight labor market would choke job
percent; and chemicals, 14.8 percent.                                     High Technology                                                 growth in 2000 seemed unfounded.
     Much of the state’s international out-                                    High-tech manufacturing has made                           Nonfarm employment surged ahead
put goes directly to Mexico (Chart 3 ).                                   steady gains in Texas in the past decade.7                      another 4.5 percent (29,500 jobs) despite
Thus, the overall economic climate in                                     The cumulative output of firms like                             an average unemployment rate of 2 per-
Mexico is key to maintaining the good                                     Texas Instruments, Dell Computer Corp.                          cent. The unemployment rate held
times in Texas foreign trade. Texas’                                      and Compaq Computer Corp. now                                   steady at 2 percent from July to Novem-
southerly neighbor did not disappoint in                                  makes up 4.9 percent of Texas GSP, a                            ber before dropping to an exceptional
2000, swallowing up $38.3 billion in                                      marked increase from the 1.7 percent                            1.7 percent in December. While job
exports over the first three quarters. This                               share in 1990. Not only has high tech                           growth fell off in September and Octo-
translated into a 31 percent jump over                                    contributed more to GSP, but expansion                          ber, it recovered in November and De-
1999. Real Mexican GDP grew 5.3 per-                                      of the industry has fueled much of the                          cember, increasing 5.1 percent and 4.3
cent in 2000.5                                                            statewide economic growth over the past                         percent, respectively.
     Texas companies shipped $10.8 bil-                                   decade as well. The high-tech sector                                 A 10 percent jump in durable goods
lion in electronic goods and $5.4 billion                                 accounts for over 10 percent of Texas                           employment (7,200 jobs) and a 7.5 per-
in transportation equipment to Mexico                                     GSP growth in the past 10 years.                                cent increase in wholesale trade employ-
in the first three quarters of 2000—                                           The year 2000 turned out to be quite                       ment led job growth in 2000. Services
increases of 38 percent and 20 percent,                                   a speed bump for high tech in Texas,                            employment increased 6.4 percent, and
respectively, over a year earlier. Mexico                                 though. Telecommunication service pro-                          transportation, communications and pub-
also bought $3.6 billion in industrial                                    viders substantially underperformed the                         lic utilities (TCPU) employment grew 3.6
machinery and equipment and $2.5 bil-                                     market, which led to widespread con-                            percent.
lion in chemicals from Texas.                                             solidation and company failures. Weaker                              High demand for software, semicon-
     Mexico’s maquiladoras realized strong                                than expected earnings among computer                           ductors and consumer electronics sus-
growth in 2000. Total employment in the                                   and semiconductor firms and a bubble                            tained the Austin business environment
sector increased 15.9 percent (128,799                                    bursting in the Internet sector also con-                       in early 2000. Fallout from the 1997

                                                     FEDERAL RESERVE BANK OF DALLAS SOUTHWEST ECONOMY MARCH /APRIL 2001                                                               3
      Chart 4                                                                                                                                                           air and ground freight business declined
                                                                                                                                                                        in the wake of a slowing national econ-
      Employment Level Increases                                                                                                                                        omy.
      January– December 2000 (in thousands)                                                                                                                                  Homebuilding in Dallas was particu-
      100
                                                                                                                                                     92.9
                                                                                                                                                                        larly strong in 2000. Single-family build-
                                   2000 Employment Shares
       90                                                                                                                                                               ing permits increased 16.3 percent from
                                                El Paso
       80
                                   Rest of Texas 3%                                                                                                                     January to November.10 An oversupply in
                                       13%                      Houston
                     Oil Patch                                   22%
                                                                                                                                            73.2                        the multifamily market squelched apart-
       70               1%                                                                                                                                              ment building, however. Multifamily per-
                              Dallas                              Farm Belt
       60
                              22%                                    3%                                                                                                 mits dropped 40.5 percent on the year.
                                                                 San Antonio
       50                Central                                     7%
                                                                                                                                                                        While increased energy prices translated
                          3%
       40                                                 Austin    Border
                                                                      3%
                                                                                                                                                                        into statewide growth in mining em-
                    Fort Worth–                            7%
                     Arlington
                                                           Gulf Coast                                             27.4            29.5                                  ployment, these jobs did not show up in
       30                8%
                               North Texas
                                   3%
                                                               5%
                                                                                                                                                                        Dallas. Mining employment declined 4.6
       20                                                                                             18.5
                                                                                            16.4
                                                                                                                                                                        percent on the year because of industry
       10
                               4.5          5             5.2         5.9        7.6                                                                                    consolidation and firm relocations to
                2
        0                                                                                                                                                               Houston. Though not as extreme as
             Oil Patch       El Paso        Gulf
                                           Coast
                                                      North
                                                      Texas
                                                                     Central   Farm Belt    San
                                                                                           Antonio
                                                                                                      Border   Fort Worth–
                                                                                                                Arlington
                                                                                                                                  Austin   Houston   Dallas             Austin’s, the Dallas labor market was
                                                                                                                                                                        among the tightest in the state, register-
      NOTES: Border comprises Laredo, Brownsville and McAllen. Central comprises Waco, Bryan and Killeen. Farm Belt comprises Abilene,
             San Angelo, Amarillo and Lubbock. Gulf Coast comprises Brazoria, Beaumont, Galveston, Corpus Christi and Victoria. North Texas                             ing a 2.8 percent unemployment rate in
             comprises Texarkana, Longview, Tyler, Sherman and Wichita Falls. Oil Patch comprises Midland – Odessa.
                                                                                                                                                                        December.
      SOURCES: Bureau of Labor Statistics; Federal Reserve Bank of Dallas.
                                                                                                                                                                             The Fort Worth economy plowed
                                                                                                                                                                        ahead in 2000 and continues to benefit
                                                                                                                                                                        from economic synergies with Dallas.
                                                                                                                                                                        Overall nonfarm employment grew a
    Asian financial crisis had a less-than-                                                ment grew a whopping 4.8 percent                                             solid 3.5 percent (27,400 jobs) for the
    expected effect on the economy, thanks                                                 (92,900 jobs) from January to December.                                      year. Construction employment out-
    to pent-up demand for high-tech goods.                                                      TCPU employment led all sectors,                                        paced all other sectors in Cowtown,
    Nevertheless, Austin was not immune                                                    with an 8.3 percent growth rate in 2000.                                     increasing 11.8 percent. FIRE jobs rose
    to high-tech market difficulty. As the                                                 Employment in construction and services                                      7.4 percent; TCPU employment, 4.7 per-
    dot.com center of Texas, Austin saw                                                    followed, increasing 7.1 percent and 6                                       cent; and wholesale trade employment,
    three major Internet companies fold in                                                 percent, respectively. Dallas continued                                      3.7 percent.
    2000. Eight more are expected to follow                                                its role as a major distribution center and                                       Recent investment in the Fort Worth
    in 2001.                                                                               retail outlet. As a result, jobs in both                                     Alliance Airport and the adjacent indus-
         Falling equity prices may have                                                    wholesale and retail trade increased                                         trial park has catalyzed an increase in
    affected spending for some high-end                                                    more than 4 percent. But later in 2000,                                      economic activity. High-tech prospects
    products late in the year. Sales of homes
    priced above $500,000 dropped off near
    the end of 2000, suggesting that New
    Economy employees were not “feeling”                                                      Chart 5
    as rich.
                                                                                              Texas Total and Major Area Employment
         The economic and high-tech situa-                                                    Index, January 1998 = 100
    tion in Austin is still very good, how-
                                                                                              118
    ever. There seemed to be no slowing                                                                                  Austin
                                                                                              116
    in business investment; venture capital                                                                              Dallas
    funding for the first three quarters of                                                   114                        Fort Worth–Arlington

    2000 reached a record $1.3 billion on                                                     112
                                                                                                                         Texas
                                                                                                                         Houston
    102 deals, up from $407 million on 75                                                     110                        San Antonio
    deals in the first three quarters of 1999.9                                                                          El Paso
                                                                                              108
         Dallas/Fort Worth. Dallas’ favorable
    business environment and large airport                                                    106

    hub, combined with a growing national                                                     104

    economy, kept the city on a solid growth                                                  102
    path throughout 2000. The local econ-                                                     100
    omy profited from major construction
                                                                                                98
    activity, early strength in the high-tech                                                                             1998                                       1999                      2000
    sector and robust international and                                                       SOURCES: Bureau of Labor Statistics; Federal Reserve Bank of Dallas.

    domestic trade. Total nonfarm employ-


4                                                                  FEDERAL RESERVE BANK OF DALLAS SOUTHWEST ECONOMY MARCH /APRIL 2001
in Fort Worth are strong and continue to      below the national rate of 4 percent.         winds, however. Statewide growth is
gain steam, as evidenced by a recent               While higher oil prices stoked eco-      expected to surpass that of the United
American Electronics Association study        nomic activity in Houston, employment         States as a whole in 2001.
that pinpointed the combined Dallas/          growth in the energy sector was some-
Fort Worth area as the fastest-growing        what muted in 2000. Mining employ-                                                      —John Thompson
high-tech center in the country. How-         ment (which includes oil and gas ex-
ever, Fort Worth saw employment losses        traction) grew a moderate 2.9 percent,        Thompson is an assistant economist in the
in mining and manufacturing in 2000.          compared with 3.6 percent statewide.          Research Department at the Federal Reserve
The December unemployment rate regis-         Construction employment grew 6.4 per-         Bank of Dallas.
tered 2.6 percent.                            cent. Single-family permits rose 6.2
     El Paso. Spurred by steady growth in     percent through November, as Houston          Notes
the maquiladoras, increases in the num-       experienced rather strong demand for               Thanks to Bill Gilmer, Keith Phillips and Lucinda Vargas for their input
                                                                                                 and to Mine Yücel and Steve Brown for helpful comments.
ber of call centers and high construction     new homes. However, multifamily per-          1
                                                                                                 All percent changes in employment levels are annualized; seasonal
activity, El Paso’s economy continued to      mits dropped 25.6 percent over the                 and other adjustments by the Federal Reserve Bank of Dallas.
chug along at a fairly strong pace. Over-     same period.                                  2
                                                                                                 Sigalla, Fiona, and Mine K. Yücel (2001), “Another Great Texas
all nonfarm employment grew 1.8 per-               San Antonio. Military downsizing and          Boom,” Federal Reserve Bank of Dallas Southwest Economy, Issue 1,
cent (4,500 jobs) in 2000. Much of this       declines in mining and manufacturing               January/February, 1–5.
                                                                                            3
                                                                                                 Some of the record increase in net income emanated from the pro-
growth was fueled by firms tied to the        employment dampened San Antonio’s
                                                                                                 ceeds from asset sales related to the 1999 merger of Exxon Corp. and
maquiladora industry, as jobs in trans-       economic growth throughout most of                 Mobil Corp.
portation, warehousing, finance, account-     2000. However, relative strength in the       4
                                                                                                 These figures from Stock Performance by Industry, The Year in Review,
ing and customs were rapidly added to         service-producing sector kept the local            2000, Morningstar, Inc.
                                                                                            5
the economy.                                  economy moving. The combined effect                Seasonal adjustment by the Federal Reserve Bank of Dallas.
                                                                                            6
                                                                                                 These figures, from Texas A&M International University’s College of
     TCPU employment rose 9.2 percent         of these forces put total nonfarm em-
                                                                                                 Business Administration and Graduate School of International Trade,
on the year, while services employment        ployment growth at 2.3 percent (16,400             measure the U.S. dollar values of total trade activity through the bor-
increased 3 percent. The apparel industry     jobs) on the year. As in most Texas met-           der cities, including transshipments.
in El Paso continues to suffer in NAFTA’s     ropolitan areas, San Antonio’s labor mar-     7
                                                                                                 High-tech manufacturing is defined here by Standard Industrial Clas-
wake, but emerging maquiladoras have          ket was squeezed tight, with the unem-             sifications 357, 366 and 367.
                                                                                            8
                                                                                                 From Stock Performance by Industry, The Year in Review, 2000, Morn-
absorbed many displaced workers.              ployment rate measuring 3 percent in
                                                                                                 ingstar, Inc.
     El Paso is a growing hot spot for call   December.                                     9
                                                                                                 PricewaterhouseCoopers, MoneyTree U.S. Report, Third Quarter 2000.
centers. Recent investments by insurance           Kelly Air Force Base is set to shut      10
                                                                                                 Building permit figures and construction contract values are measured
and telemarketing firms pushed call           down the last of its operations in 2001.           in five-month moving averages.
center employment to about 9,300 work-        Employment at the facility has dropped
ers. The new centers are increasing their     from 20,000 in the early 1990s to about
reliance on modern information tech-          2,400 employees, who will leave over
nology and are demanding employees            the next several months. Despite this
with better skills. As a result, wages        loss and declines in manufacturing
in business services have been climb-         employment, the San Antonio economy
ing. Construction employment increased        is in good shape.
5.5 percent, and retail trade grew 1.1             Wholesale trade employment grew
percent, but manufacturing employ-            3.2 percent in 2000, and retail trade
ment declined. The December unem-             increased 2.7 percent. Services employ-
ployment rate came in at a record low         ment grew 2.9 percent. The peso’s cur-
7.3 percent.                                  rent strength relative to the dollar, com-
     Houston. The Houston economy con-        bined with the near completion of
tinued to ride a wave triggered by the        construction at the downtown conven-
coincidence of a strong U.S. and global       tion center, promises to stimulate retail
economy and high energy prices. During        sales. In addition to a solid trade sector,
2000, Houston nonfarm employment              business services employment will con-
grew 3.6 percent, adding 73,200 jobs to       tinue to grow as call centers locate in
the local economy. Employment gains           San Antonio.
were led mostly by the service-produc-
ing sectors, with retail trade and TCPU       Outlook
both increasing 3.9 percent and FIRE              Moderated economic growth is antici-
growing 2.5 percent. Services employ-         pated in 2001, with a slowing U.S. econ-
ment rose 3.6 percent and manufactur-         omy the primary threat to Texas. High
ing employment 3 percent. Houston’s           energy prices and sustained export trade
unemployment rate fell to 3.5 percent         with Mexico and Asia should buffer
in December, a half percentage point          the state against unfavorable economic

                                 FEDERAL RESERVE BANK OF DALLAS SOUTHWEST ECONOMY MARCH /APRIL 2001                                                                     5
    Bank Competition in the New Economy                                                                                                        Indonesia and Russia, were all related to
                                                                                                                                               unhealthy, fragile banking sectors.
    (Continued from front page)                                                                                                                     In particular, a comparison with Japan
                                                                                                                                               highlights the importance of banking to
                                                                                                                                               economic health. While the United States
    only in the banking sector, but also in                                  term, whether increased competition will                          experienced many bank failures during the
    the financial sector, which includes                                     follow; greater access to a market does                           savings and loan crisis of the late 1980s, it
    banking, insurance, securities underwrit-                                not guarantee new entrants success.                               established institutions, like the Resolution
    ing and similar businesses.                                                                                                                Trust Corp., to quickly deal with the failed
         This article explores the likely impact                             An Engine of Economic                                             banks. Once the banking system was
    of these recent events on both concen-                                   Growth and Stability                                              restored to health, economic growth
    tration and competition within the bank-                                      Although banking has not generated                           ensued. In contrast, Japan did not swiftly
    ing and financial sectors. It is important                               the headlines garnered by the Internet                            reform its banking sector after suffering
    to distinguish between concentration and                                 phenomenon, it has been crucial to sus-                           many large bank failures in the 1990s, and
    competition. Concentration refers to the                                 taining the New Economy. Banks have                               the banking system’s ongoing ills have
    market share held by the largest produc-                                 traditionally played the pivotal role in                          contributed to Japan’s 10-year malaise.
    ers in an industry; competition refers to a                              providing financial capital via loans.                                 Given the importance of the banking
    company’s ability to dictate prices.                                     Over the past few decades, however,                               sector to economic growth, it is vital to
    Although the two are linked, highly con-                                 firms have gained access to a variety of                          understand how financial deregulation,
    centrated industries are not necessarily                                 financing sources (Chart 1 ). As a result,                        with the resulting consolidation in the
    less competitive. For example, although                                  banks have adapted, with larger banks                             banking sector, and technological evolu-
    there are fewer than 10 major banks in                                   now also providing venture capital for                            tion, especially the rise of the Internet,
    Canada (high concentration), the bank-                                   start-ups and securities underwriting for                         will affect the economy. In particular, how
    ing system is extremely competitive                                      initial public offerings and with smaller                         does the degree of competition within the
    because all banks compete against each                                   community banks still providing loans                             banking system affect economic growth
    other in every region of the country.                                    for local businesses.                                             and prosperity? And, will the specific
         The elimination of some legal re-                                        Bank stability has also been critical                        events listed above affect the level of
    strictions on banks’ activities as a result of                           to our recent prosperity. During much of                          competition in the financial sector?
    financial deregulation has contributed to                                the 19th and early 20th centuries, every
    numerous mergers and fewer banks. The                                    major recession was preceded by bank                              Financial Sector Structure
    impact has been to increase concentra-                                   failures. Since the inception of the Fed-                         and Economic Growth
    tion in the banking industry without less-                               eral Reserve System in 1914, both the                                  Although recent mergers and legisla-
    ening competition between banks. The                                     banking system and the economy have                               tion are unlikely to lead to a monopoly
    effect of technological innovations is less                              been far less volatile. The importance of                         in financial services, it is, nevertheless,
    clear. While better technology generally                                 a stable banking sector was also demon-                           important to understand the effects of
    helps lower costs, allowing easier entry                                 strated recently when economic prob-                              reduced competition. There are both
    by new competitors, it is unclear, long                                  lems in other countries, such as Japan,                           detrimental and beneficial aspects of
                                                                                                                                               reduced competition in the financial ser-
                                                                                                                                               vices industry.1
                                                                                                                                                    As economics textbooks teach, re-
      Chart 1                                                                                                                                  duced competition in any market harms
       Source of Funds in the United States                                                                                                    the macroeconomy by raising prices and
       Percentage of assets held                                                                                                               reducing output. In banking, this might
                                                                                                                                               translate into higher fees, higher loan
                                   Other
                                   3.1%
                                                                                                       Other
                                                                                                       7.4%
                                                                                                                                               interest rates, lower deposit interest rates
                   Thrifts                                                                   Thrifts                      Commercial
                   12.3%                                                                     4.4%                           banks              and fewer new services. Higher loan
                                                                                                                            22.1%
                                                                                                                                               rates result in less productive and more
                                                                                Insurance                                                      risky projects obtaining funding and
                                                                                companies
                                                                                  14.8%
                                                                                                                                               increase the likelihood of bankruptcies
                                     1948                Commercial
                                                           banks
                                                                                                           1999                                and defaults. Lower interest rates on
       Insurance
       companies                                           55.9%                                                                               deposits and higher fees for services
         24.3%
                                                                                                                                               reduce the savings available to finance
                                                                                     Investment                              Pension funds     investment. These distortions on fees and
          Investment                                                                 companies                                  29.6%
          companies                                                                    21.7%                                                   interest rates reduce productive invest-
             1.3%            Pension funds
                                 3.1%                                                                                                          ment, lessen growth and lower our stan-
      SOURCES: Anthony Saunders and Ingo Walter (1996), Universal Banking: Financial System Design Reconsidered (Chicago: Irwin Professional
                                                                                                                                               dard of living.
               Publishing); Federal Reserve Board of Governors.                                                                                     The benefits of a less competitive
                                                                                                                                               banking system are less well known.


6                                                      FEDERAL RESERVE BANK OF DALLAS SOUTHWEST ECONOMY MARCH /APRIL 2001
Reduced competition helps overcome the         Table 1
biggest problem facing borrowers and
lenders: a lack of information. Usually,        Dollar Value of Recent U.S. Bank Mergers
the largest costs banks incur when mak-
                                                                                                                                                              Asset value of
ing loans come from obtaining informa-                                                                                                                    acquired/merged firm
tion about prospective borrowers. With a                                                          Acquired or merged bank                                 (in billions of dollars)
competitive banking system, it is likely        Total value for 1998 (Top 50 bank holding companies)                                                                1,017
that more than one bank will seek infor-        Largest mergers
mation about a borrower, a cost duplica-          Travelers Group              Citibank                                                                               311
tion that wastes resources. Also, once a          NationsBank                  BankAmerica and Barnett Banks                                                          304
                                                  Bank One Corp.               First Chicago NBD Corp. and                                                            132
borrower secures a loan, it is possible                                        First Commerce Corp.
for the funds to be redirected to highly
risky or inappropriate projects. Monop-         Total Value for 1999 (Top 50 bank holding companies)                                                                  309
                                                Largest mergers
oly banks, in general, can exert greater          Deutsche Bank                Bankers Trust                                                                          156
influence over how funds are used, since          Fleet Financial Group        BankBoston Corp. and Matewan BancShares                                                 76
the borrower has no other access to               Firstar Corp.                Mercantile Bancorporation                                                               36
future funds.                                   Total Value for 2000 (Top 50 bank holding companies)                                                                  494
     Whether the costs of a less competi-       Largest mergers
tive banking system outweigh the bene-            Chase Manhattan Corp.       J.P. Morgan & Co.                                                                       282
fits depends on the severity of the infor-        Citigroup Inc.              Associates First Capital Corp.                                                           93
mation problems. In the United States,            Wells Fargo & Co.           First Security Corp.                                                                     23
where information retrieval is relatively       SOURCE: Federal Reserve Board of Governors.
inexpensive, the costs from a reduction
in competition would likely outweigh
the benefits, thereby adversely affecting
the nation’s macroeconomic well-being.       1997, banks have been allowed to own                                           Numerous studies have analyzed the
                                             and operate branches in different states.                                 effects of mergers on concentration in
Will Deregulation                            Equally important, though, the recent                                     banking.3 Mergers have had little impact
Lessen Competition?                          wave of mergers is the result of banks                                    on local market concentration. At the
     Given that less competition is detri-   attempting to achieve larger, more cost-                                  national level, mergers have increased
mental to the overall economy, what are      efficient organizations. For example,                                     concentration somewhat—although not
the likely net effects on the degree of      mergers often eliminate duplicate serv-                                   enough to dramatically alter the indus-
competition as a result of recent deregu-    ices such as branches, automated teller                                   try’s competitive nature. In addition, the
lation and technological innovation?         machines and information technology-                                      U.S. banking industry remains much less
Financial deregulation, especially laws      related services.                                                         concentrated than that in many coun-
passed in 1994 and 1999, has spurred
considerable merger activity within the
banking sector and is also likely to lead      Table 2
to consolidation throughout the financial
sector.                                         Summary of Federal Banking Legislation
     Banking Sector Consolidation. Like                          Legislation                                                             Impact
many areas of the economy, the banking
                                                Federal Reserve Act of 1913                                 Established the Federal Reserve System
sector has experienced numerous merg-
                                                McFadden Act of 1927                                        Placed national and state banks on equal footing
ers of late, notably Citicorp with Travel-                                                                  regarding branching; prohibited banks from branching
ers Group, NationsBank with BankAmer-                                                                       across state lines
ica and, most recently, Chase Manhattan         Banking Act of 1933 and 1935                                Established the Federal Deposit Insurance Corp.;
with J.P. Morgan. These mergers have            (Glass – Steagall)                                          separated commercial and investment banking
involved not only the largest banks but         Bank Holding Company Act of 1956                            Gave the Federal Reserve regulatory oversight and
also numerous other banks with consid-          and Douglas Amendment of 1970                               established rules governing bank holding companies
erable asset values (Table 1 ).                 Financial Institutions Reform, Recovery,                    Established the Office of Thrift Supervision and Resolution
     Many recent mergers have been made         and Enforcement Act of 1989                                 Trust Corp. to clean up savings and loan crisis;
possible in part by the Riegle –Neal                                                                        provided funding to resolve savings and loan failures
Interstate Banking and Branching Effi-          Riegle – Neal Interstate Banking and                        Allowed interstate banking and branching across
ciency Act of 1994. This law repealed           Branching Efficiency Act of 1994                            state lines
the McFadden Act of 1927 and Douglas            Gramm – Leach – Bliley Financial Services                   Eliminated barriers separating commercial banking,
                                                Modernization Act of 1999                                   investment banking and insurance
Amendment of 1970, which curtailed
interstate banking.2 (Table 2 summarizes        SOURCE: Mishkin, Frederic S. (1998), The Economics of Money, Banking, and Financial Markets, 5th ed. (New York: Addison –Wesley).
some of this federal legislation.) Since

                                FEDERAL RESERVE BANK OF DALLAS SOUTHWEST ECONOMY MARCH /APRIL 2001                                                                                   7
    tries. Finally, increased concentration
    also leads to greater banking stability.                                                 Mergers and New Bank Formation
    Having more regional and national
                                                             Although mergers over the past decade have reduced the number of banking institutions in the
    banks and fewer local banks should                United States, the increase in bank mergers in the second half of the 1990s also coincided with an
    reduce the incidence of bank failures             increase in new bank charters. Economic research has yet to establish a conclusive connection (causality)
    because larger banks tend to have more            between these two events. Seelig and Critchfield (1999) find that mergers do not lead to increased bank
    diversified portfolios, which can better          formation. Consolidation within a local market results in fewer, more concentrated banks that can more
    absorb adverse economic shocks.                   easily act to bar potential entrants.
         As for competition, there are few                   However, Berger et al. (1999) find that mergers can increase new bank formation. Mergers often
                                                      involve acquisition of smaller banks by larger banks or local banks by distant banks, leading to a reduction
    signs that banking is becoming less com-
                                                      in personal, local services and dissatisfaction among the acquired bank’s customers. This provides a
    petitive. Recent studies find little evi-         market for new, local banks to serve the dissatisfied constituents. Keeton (2000) also finds that mergers
    dence of a decrease in the number of              are likely to lead to new bank formation.1 This relationship is strongest when mergers involve smaller
    small business loans, of higher prices for        banks being acquired by larger banks or local banks by distant banks.
    services or of increased profits resulting               Thus, merger activity appears to provide the stimulus for new bank formation. This is an additional
    from a more concentrated market —all              reason why the banking sector will continue to be competitive in spite of (or as a result of) recent merger
    indicators of a less competitive market.4         activity.
    Even if the industry were to become               1
                                                          This article provides a good overview and explanation of the other two articles cited above.
    highly concentrated, it is doubtful that
    this would have a negative effect on
    bank competition. It is probable that our      scale that motivate mergers solely                                               petition is an open question, especially
    banking system, like Canada’s, would           between banks. Recent studies conclude                                           given the recent rash of business failures
    have fewer (potentially more efficient)        that banks benefit from diversifying into                                        in the high-tech sector. Thus, the overall
    banks, but still be highly competitive.        certain types of insurance underwriting                                          impact of technological change on com-
    (See box titled “Mergers and New Bank          and that investments in insurance under-                                         petition in the financial system is
    Formation.”)                                   writing and securities brokerage can re-                                         ambiguous.
         Financial Sector Consolidation. In        duce the probability of insolvency.6                                                  One-Stop Shopping. Technological
    addition to recent banking mergers, con-            In the end, consolidation will likely                                       advances, combined with recent legisla-
    solidation across the financial sector is      help to create a single, unified financial                                       tive reforms, make it easier and more
    likely as a result of the passage of the       market where firms and individuals can                                           efficient for firms to obtain financing
    Gramm–Leach–Bliley Financial Services          address all their financial needs at a                                           from a single entity capable of handling
    Modernization Act of 1999, which re-           single integrated financial company. Eco-                                        everything from loans to stock offerings
    pealed parts of the Glass–Steagall Act         nomic research suggests that removal of                                          to insurance. This one-stop shopping
    (officially known as the Banking Act of        statutory barriers between banking, insur-                                       should reduce the costs firms currently
    1933). Glass–Steagall had separated bank-      ance and securities will result in fewer                                         incur finding various companies to meet
    ing, insurance and investment banking          banks but a more competitive financial                                           these different needs. It will also lessen
    into three distinct, nonoverlapping sec-       system.7 As with mergers within the bank-                                        the information-gathering costs finance
    tors (for example, banks could not offer       ing sector, consolidation will likely occur                                      companies incur by facilitating more
    insurance or underwrite securities and         within the financial sector without an                                           efficient exchanges of information. Both
    vice versa). Although the legal barriers       appreciable loss of competition.                                                 of these benefits strengthen the com-
    between these three activities had eroded                                                                                       petitive environment. These cost-saving
    over time, they still prevented banks          Technology, Banking                                                              benefits also apply to consumers, who,
    from completely entering the other two         and the New Economy                                                              for example, can use the Internet to find
    businesses. For example, although Citi-              In addition to the legal reforms,                                          multiple rates for car loans and mort-
    corp (a bank) and Travelers Group (an          another major force affecting the bank-                                          gages.
    insurance company) merged in 1998, if          ing industry is the rapid advancement in                                              However, there are two other issues
    not for the repeal of Glass –Steagall, Citi-   technology and the Internet. Consolida-                                          to consider when examining competi-
    group, the resulting company, would have       tion in financial markets, along with                                            tion. First, the creation of integrated
    been required to divest its insurance          technological advances, may bring about                                          finance companies may result in a few
    underwriting business in a few years.          one-stop financial shopping at a poten-                                          extremely large, national financial com-
         The Financial Services Moderniza-         tially limited number of large, national                                         panies but eliminate small local firms
    tion Act of 1999 will likely foster a con-     financial institutions. If this happens, it is                                   from the industry because they lack
    solidation of the financial sector as          not clear how concentration in the in-                                           economies of scale. These few large firms
    banks, securities firms and insurance          dustry will affect competition. In addi-                                         may, or may not, compete fiercely across
    companies combine.5 Mergers involving          tion, the Internet is creating considerable                                      all local markets. Second, it is not clear
    banks, insurance companies and invest-         competition to traditional banks from                                            whether these integrated financial com-
    ment banks will be motivated by poten-         firms both in and out of the financial sec-                                      panies will actually emerge and domi-
    tial economies of scope and diversifi-         tor. Whether these new firms can remain                                          nate the market. With lower search costs,
    cation rather than by the economies of         in business and provide sustained com-                                           both businesses and consumers may find


8                                    FEDERAL RESERVE BANK OF DALLAS SOUTHWEST ECONOMY MARCH /APRIL 2001
it cost-efficient to continue using differ-   began offering this service. Thus, in the                                    4
                                                                                                                               Although fees for some services (ATM, overdraft and so forth) have
ent financial companies to handle their       future, traditional banks could face                                             been rising, these increases are not directly linked to greater concen-
                                                                                                                               tration and less competition in the banking sector.
various needs. This would eliminate the       greater competition sparked by new tech-                                     5
                                                                                                                               As of March 2, 2001, the Federal Reserve Board had granted 509 firms
anticipated savings derived from having       nology and the Internet. However, the                                            financial holding company status, a first step toward being allowed to
integrated financial companies. Conse-        long-term viability of these new com-                                            combine banking, insurance and securities underwriting.
quently, the impact on competition is         petitors, as well as traditional banks’ for-                                 6
                                                                                                                               For recent work regarding the impact of banks’ expansion into insur-
unclear.                                      ays into the Internet, remains uncertain.                                        ance and securities underwriting, see Laderman (2000) and the refer-
                                                                                                                               ences therein.
     The Internet and Outside Competi-                                                                                     7
                                                                                                                               See Boot and Thakor (2000).
tion. The Internet and new technologies       An Evolving, Competitive                                                     8
                                                                                                                               Examples of Internet-only banks include Net.B@ank and First Internet
may also increase competition by making       Banking System                                                                   Bank of Indiana; an example of a nonbank is Sony; examples of
it harder to exclude new entrants. New             An important, although often over-                                          traditional banks include Citigroup’s Citi f/i and Bank One’s Wing-
technology makes both workers and             looked, source of our recent economic                                            spanbank.com. North Fork Bancorporation is an example of a bank
                                                                                                                               that decided against an Internet bank due to cost constraints. Finally,
machines more efficient, thereby reduc-       prosperity has been our healthy and                                              Citigroup’s Citi f/i is an example of an Internet-only bank that has been
ing fixed costs, start-up costs and operat-   stable banking sector. While avoiding                                            absorbed by its bricks-and-mortar parent company.
ing costs. This makes it easier for poten-    major problems, the banking and finan-
tial new competitors to enter a market.       cial sectors have been subject to numer-                                     References
     With the advent of Internet banking,     ous changes that have affected their                                         Berger, Alan N., Seth D. Bonime, Lawrence G. Goldberg and
new banks (both large and small) are          underlying structure.                                                        Lawrence J. White (1999), “The Dynamics of Market Entry: The
able to compete against the more tradi-            The two major forces affecting com-                                     Effects of Mergers and Acquisitions on De Novo Entry and
tional bricks-and-mortar banks. In the        petitiveness have been financial deregu-                                     Small Business Lending in the Banking Industry,” Board of
last two to three years, the banking sec-     lation and technological innovation. As a                                    Governors of the Federal Reserve System, Finance and Eco-
tor has seen the formation of stand-alone     result of deregulation, merger activity                                      nomics Discussion Series no. 1999-41, July.
Internet-only banks, nonbanking busi-         within the banking sector will continue,
nesses forming Internet banks and large,      albeit at a slower pace, while the extent                                    Boot, Arnoud W.A., and Anjan V. Thakor (2000), “Can Relation-
traditional banks forming Internet-only       of merger activity in the broader finan-                                     ship Banking Survive Competition?” Journal of Finance 55
banks. Thus, it has already become            cial sector is still unclear. Although these                                 (April): 679–713.
extremely hard to exclude new banks           consolidations are likely to result in a                                     DeYoung, Robert (1999), “Mergers and the Changing Land-
from a market. However, merely having         more concentrated banking sector, the                                        scape of Commercial Banking (Part I),” Federal Reserve Bank of
access to the market is not sufficient        impact on financial market competition                                       Chicago Chicago Fed Letter, No. 145, September.
to guarantee competition. Some smaller        will probably be negligible. Mergers will
banks have decided not to form Internet-      lead to fewer, larger banks that compete                                     Guzman, Mark G. (2000), “The Economic Impact of Bank Struc-
only banks because they do not have the       fiercely across national markets and may                                     ture: A Review of Recent Literature,” Federal Reserve Bank of
resources to compete. Also, many Inter-       spur new, smaller competitors at the                                         Dallas Economic and Financial Review, Second Quarter, 11–25.
net-only banks have either merged,            local level.                                                                 Keeton, William R. (2000), “Are Mergers Responsible for the
exited the market or been swallowed up             The effects of consolidation may                                        Surge in New Bank Charters?” Federal Reserve Bank of Kansas
by more traditional banks.8                   also be more than offset by the increased                                    City Economic Review, First Quarter, 21–41.
     In addition to competing with Inter-     competition stemming from the Internet
net start-ups, traditional banks are begin-   and new technologies that make it easier                                     Laderman, Elizabeth S. (2000), “The Potential Diversification
ning to face competition from non-            for both nontraditional banks and non-                                       and Failure Reduction Benefits of Bank Expansion into Non-
financial sources, including AOL Time         bank firms to compete with more tradi-                                       banking Activities,” Federal Reserve Bank of San Francisco
Warner, Microsoft Corp., Yodlee and           tional banks.                                                                Working Paper no. 2000-01 (San Francisco, January).
CheckFree Corp. Two major areas of new                                              —Mark G. Guzman                        Moore, Robert R., and Thomas F. Siems (1998), “Bank Mergers:
competition are electronic bill payment                                                                                    Creating Value or Destroying Competition?” Federal Reserve
and presentment (EBPP) and account            Guzman is an economist in the Research                                       Bank of Dallas Financial Industry Issues, Third Quarter, 1–6.
aggregation (the ability to view all one’s    Department at the Federal Reserve Bank
financial accounts on a single web page).                                                                                  Osterberg, William P., and James B. Thomson (1999), “Banking
                                              of Dallas.
Both EBPP and account aggregation                                                                                          Consolidation and Correspondent Banking,” Federal Reserve
have recently become areas of intense                                                                                      Bank of Cleveland Economic Review, First Quarter, 9–20.
competition between banks and non-            Notes                                                                        Seelig, Steven A., and Timothy Critchfield (1999), “Determi-
                                                  Thanks to John Duca, Pia Orrenius, Alan Viard and Kay Champagne
banks. Many companies in addition to                                                                                       nants of De Novo Entry in Banking,” Federal Deposit Insurance
                                                  for helpful comments and suggestions.
banks, including the U.S. Postal Service      1
                                                  Guzman (2000) provides a detailed overview of some of the recent         Corp. Working Paper no. 99-1.
and Microsoft, offer bill-payment ser-            literature examining the theoretical impact of financial sector market
vices, while most portals, such as                structure on the economy. See the references therein for a more          Stiroh, Kevin J., and Jennifer P. Poole (2000), “Explaining the
Yahoo!, and financial web sites, such as          detailed explanation of some of the ideas mentioned in this section.     Rising Concentration of Banking Assets in the 1990s,” Federal
                                              2
                                                  Not all interstate branching was eliminated, since various states        Reserve Bank of New York Current Issues in Economics and
Quicken.com, offer account aggregation.
                                                  entered into regional pacts that allowed some interstate branching or    Finance, August.
In fact, account aggregation was pro-             holding companies.
vided by nonbank firms long before            3
                                                  For recent works, see Stiroh and Poole (2000), Osterberg and Thom-
many larger banks, such as Citigroup,             son (1999), DeYoung (1999) and Moore and Siems (1998).



                                 FEDERAL RESERVE BANK OF DALLAS SOUTHWEST ECONOMY MARCH /APRIL 2001                                                                                                    9
                                                     Beyond the Border

                                         Why Free Trade in the Americas?

     T         his April Quebec City will host
               the third summit of the ongoing
               Free Trade Area of the Americas
     (FTAA) initiative. But even though Presi-
     dent Bush will attend and has made
                                                    Coe, Helpman and Hoffmaister (1997)
                                                    show that productivity growth in de-
                                                    veloping countries increases with the
                                                    openness of their trade with developed
                                                    countries and with the research and
                                                                                                                     imports but also exports. High tariff bar-
                                                                                                                     riers, after all, make imports more costly.
                                                                                                                     When these imports are used as inputs
                                                                                                                     to products that are exported—or when
                                                                                                                     they embody new technologies that
     trade liberalization in the Americas a         development efforts of their industrial-                         make production of potential export
     high priority for his administration, many     ized trading partners.                                           products cheaper and more efficient—
     Americans’ attitude toward FTAA— if                 And yet most Western Hemisphere                             then high import barriers also mean low
     they are aware of it at all —is likely to be   developing countries, the targets of the                         export-to-GDP ratios. Moreover, as pre-
     “So what?” Compared with the time and          FTAA, are not very open to trade and                             viously noted, lower trade generally
     space the media devote to other topics,        also do not generally trade very much.3                          means lower GDP.
     the attention FTAA has received in recent      For the average lower or middle-income
     years suggests that a free trade agree-        country —a broad category that includes                          Why Liberalize Trade?
     ment spanning the Western Hemisphere           all Western Hemisphere nations except                                 To answer the question “So what?”
     carries far less news value than the aver-     the United States and Canada—exports                             about trade agreements, politicians who
     age four-car pileup.                           as a percentage of GDP run about 21                              advocate trade liberalization generally
           But FTAA is much more important to       percent. Exports of Latin American and                           respond that it provides more jobs. Jobs
     the economies of the Americas than this        Caribbean countries average about 14                             are a red herring. While trade liberaliza-
     lack of interest would indicate. FTAA          percent of GDP; South American coun-                             tion typically results in increased output
     would mean lower trade barriers in Latin       tries separately average about 11 per-                           by each participating country, the real
     American countries, where average tariffs      cent. Chart 1 compares Latin American                            benefit is increased efficiency in the form
     are two to three times those in industri-      and Caribbean export-to-GDP percent-                             of higher output per worker even if no
     alized countries.1 Some Latin Americans        ages with those of selected countries and                        more workers are employed. The reason
     oppose FTAA because they believe their         regions of the world, and the differences                        is that protectionism not only discour-
     countries would bear the brunt of virtu-       are striking.                                                    ages imports but also creates artificially
     ally all the agreement’s trade liberaliza-          A partial explanation for these low                         high profits in protected industries,
     tion. Where is the benefit, they ask,          trade ratios is the distance of the more                         diverting resources away from more pro-
     when the United States already has such        remote Latin American nations from                               ductive and efficient but less protected
     low tariffs that an FTAA agreement will        potential industrialized trading partners.                       industries.
     not lower them much more? What they            Another is that the high tariff barriers of                           In addition to artificially high profits,
     fail to consider it that even though aver-     Latin American countries compared with                           protectionism promotes inefficiency. Using
     age U.S. tariffs are markedly lower than       developed countries affect not only                              data from a 1981 survey of more than
     those of Latin American countries, some                                                                         3,000 Brazilian firms, Braga and Will-
     types of U.S. protectionism are very high.                                                                      more (1991) find that the firms’ likeli-
     Some of the products on which U.S.                                                                              hood of purchasing foreign technology
     trade barriers are highest—and most              Chart 1                                                        or of developing their own technology
     damaging to U.S. consumers —are those            Exports as a Percentage of                                     through research and development was
     for which Latin America has a marked             Gross Domestic Product                                         negatively related to the degree to which
     cost advantage.                                                                                                 their industries were protected from for-
                                                               Low- and middle-income
           A second reason for FTAA is that              East Asia and Pacific countries                             eign competition. If you don’t have to
     trade agreements typically induce partic-        Low- and middle-income European
                                                             and Central Asian countries
                                                                                                                     compete, why mess with success?
     ipants to trade more.2 Rivera-Batiz and                            United Kingdom
                                                                                                                          Opponents of trade liberalization
     Romer (1991), among others, demon-                                                                              look at it another way. They remind us
                                                                               Germany
     strate that economic integration—and that                                                                       that if these protected industries had to
     is what FTAA would be—accelerates eco-                                      France                              compete on world markets, many would
                                                                     Latin America and
     nomic growth. As a corollary, Frankel and                      Caribbean countries                              close and their employees would lose
     Romer (1999) find a correlation between                               United States                             their jobs. A closer look shows that the
     the importance of trade in a country and                                              0   5 10 15 20 25 30 35
                                                                                                                     factors of production (labor and capital)
     the country’s income level. Moreover,                                                         Percent           devoted to these industries would be
     the direction of causality runs from trade       SOURCE: World Bank.                                            reallocated to business endeavors that
     to income, not the other way around.                                                                            could be profitable without charging the


10                                    FEDERAL RESERVE BANK OF DALLAS SOUTHWEST ECONOMY MARCH /APRIL 2001
consumer-gouging prices that govern-             Chart 2                                                        Notes
ment protectionism allows. This does                                                                            1
                                                                                                                    Latin American tariffs are higher than those in industrialized countries
mean, however, that during the transi-           Average Ad Valorem Tariffs                                         even though Latin American countries have generally lowered their
                                                                                                                    tariffs significantly in recent decades.
tion from protectionism to trade liberal-        Percent
                                                                                                                2
                                                                                                                    Some Americans do not want more trade in any event, on the grounds
ization, some types of labor and capital         12
                                                                                                                    that it leads to environmental damage. For a related article, see Gruben
would be out of work.                            10                                                                 (2000).
      It is instructive, though, to consider                                                                    3
                                                                                                                    Mexico is an obvious exception.
                                                  8                                                             4
                                                                                                                    Industrialized countries here are members of the Organization of
the cost of preserving their employment
                                                                                                                    Economic Cooperation and Development, which includes the United
in protected industries. In a 1990 study          6
                                                                                                                    States, Canada, Japan, the European countries and, as a recent
of 21 trade-protected U.S. economic                                                                                 inductee, Mexico.
                                                  4
sectors, Hufbauer and Elliott (1994)
report that the average annual cost to            2
                                                                                                                References
Americans per job saved as a result of            0                                                             Braga, Helson, and Larry Willmore (1991), “Technological
                                                      United States   Europe   Japan   Canada   Latin America
trade barriers was $54,348. In contrast,                                                                        Imports and Technological Effort: An Analysis of Their Determi-
                                                 SOURCE: World Bank.
average earnings per year per worker                                                                            nants in Brazilian Firms,” Journal of Industrial Economics 39
in these industries was $15,649. In one                                                                         (June): 421–32.
sector—sugar production —the cost per
year per job saved was $256,966, even                                                                           Coe, David T., Elhanan Helpman and Alexander W. Hoffmaister
though the average worker earned only          many products. Import quantities above                           (1997), “North–South R&D Spillovers,” Economic Journal
$21,810 per year. In peanut production         these quotas then incur so-called tariff                         107 (January): 134–49.
—another highly protected endeavor—            peaks, one-fifth of which exceed 30 per-                         Frankel, Jeffrey A., and David Romer (1999), “Does Trade Cause
the average cost per job saved was             cent ad valorem. Such peak tariffs apply                         Growth?” American Economic Review 89 (June): 379–99.
$55,416, but the average annual salary         to cow’s milk (66 percent), yogurt (63
was just $17,104. Eleven years after this      percent), butter (80 percent), cheese (42                        Gruben, William C. (2000), “Trade, WTO and the Environment,”
study, many of the same products are           percent), raw cane sugar (90 percent),                           Federal Reserve Bank of Dallas Southwest Economy, Issue 1,
still highly protected.                        peanuts and peanut butter (132 percent),                         January/February, 10.
                                               chilled/frozen beef (26 percent) and                             Hertel, Thomas W. (2000), “Potential Gains from Reducing
The Price of Protectionism                     sports footwear with fabric uppers (58                           Trade Barriers in Manufacturing, Services and Agriculture,”
     Indeed, while many Americans be-          percent) (United Nations Conference on                           Federal Reserve Bank of St. Louis Review, July/August, 77–99.
lieve that the United States and other         Trade and Development 2000). Under
developed countries have lowered trade         the Generalized System of Preferences,                           Hufbauer, Gary C., and Kimberly Ann Elliott (1994), Measuring
barriers across a broad front, the overall     developing countries can export a lim-                           the Costs of Protection in the United States (Washington, D.C.:
picture is more complicated. It is true        ited number of the products at half these                        Institute for International Economics).
that the average tariff on industrial goods    rates before the peak tariffs go into                            Rivera-Batiz, Luis A., and Paul M. Romer (1991), “Economic
imported into industrialized countries         effect. But even at one-half off, these tar-                     Integration and Endogenous Growth,” Quarterly Journal of Eco-
dropped from roughly 40 percent in 1947        iff rates hurt consumers. Also, as noted                         nomics 106 (May): 531–55.
to 1.5 percent by the late 1990s (Hertel       previously, only a small portion of the
2000).4 However, agricultural protection       total income the protected companies                             Roberts, I., T. Podbury, N. Andreas and B.S. Fisher (1999), “The
has risen from about 30 percent in the         make as a result of protectionism goes to                        Dynamics of Multilateral Agricultural Policy Reform” (Paper
late 1960s to 60 percent in 1998 (Roberts      reimburse workers.                                               presented at the 1999 Global Conference on Agriculture and
et al. 1999).                                       To put these rates in perspective, it                       the New Trade Agenda from a Development Perspective: Inter-
     There is a reason for the conven-         should be noted that Japanese peak rates                         ests and Options in the WTO 2000 Negotiations, sponsored
tional wisdom, though. On average,             for many products are far higher than                            by the World Bank and World Trade Organizaton, Geneva, Octo-
trade barriers in developed countries are      those of the United States. In fact, based                       ber 1–2).
lower than those of developing coun-           on peak rates, Japan is far more protec-                         United Nations Conference on Trade and Development (2000),
tries. Chart 2 shows that average tariffs in   tionist than any other developed coun-                           “The Post-Uruguay Round Tariff Environment for Develop-
Latin America are in the 11 percent            try. Nevertheless, the fact remains that                         ing Country Exports: Tariff Peaks and Tariff Escalation” (Joint
range, compared with 4.8 percent for the       despite the ho-hum attitude of American                          study with World Trade Organization, no. TD/B/COM.1/14/
United States, 5.6 percent for the Euro-       consumers, they—and their counterparts                           Rev.1, January).
pean Union, 6.6 percent for Japan and          in other Western Hemisphere countries
7.1 percent for Canada. But these are just     —continue to feel the effects of punish-
averages. In fact, U.S. tariffs exceed 12      ing trade barriers.
percent for approximately one-tenth of
the types of products imported, and the                                        —William C. Gruben
closer you look, the worse it gets.
     For example, under the putatively         Gruben is vice president and director of the
trade-liberalizing Uruguay Round, the          Center for Latin American Economics at the
United States imposes import quotas on         Federal Reserve Bank of Dallas.


                                 FEDERAL RESERVE BANK OF DALLAS SOUTHWEST ECONOMY MARCH /APRIL 2001                                                                                        11
                                                    FEDERAL RESERVE BANK OF DALLAS


                                                   Southwest
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