Help Wanted: Part 2

Palm Coast, FL – January 11, 2011 – Generally speaking, a single industry will not determine the health of an economy. Rather, a diverse economy with multiple industries is better suited to weather economic shocks. There are many tools that can be used to track, measure and analyze various facets of the economy. One such tool is a diffusion index.

A diffusion index is used to measure how many facets of an entity like an economy grow or decline at a single point in time. For instance, a diffusion index can be used to determine if an economy’s labor market has more industries expanding than contracting — or vice versa.

To create the index, analysts give a score of “100” to an industry that grows relative to the same period one year earlier. An industry that shrinks receives a zero, and industries that do not change are given a 50. These scores are then averaged to create the index. NAR Research created such an index for each of the 159 metro markets it monitors. The average of these 159 indexes is depicted in the line chart.

An economy will have an index value greater than 50 if more than half of its industries are expanding, as is apparent in the chart reflecting the time periods during the economic expansions of the 1990s and from 2003 through 2007. Conversely, during the subsequent recessions more industries were declining than were flat or expanding, thus the index slips below 50.

In September of 2009 the average diffusion index bottomed at 20.9. That measure suggested that the recession was deep, spread across many industries, and had a broad impact. Further evidence of this is the fact that only one percent of the markets covered (as shown in the “share of metros expanding” line in the chart), were expanding or had a diffusion index of over 50.

During the spring of 2010 we finally saw signs of an early economic expansion. Layoffs paused, while job creation in some industries began to improve. By August of this year, the average diffusion index reached 41.8 with 32.7 percent of the markets registering an index above 50. The number of markets with scores between 30 and 50 rose from just 23 in September of 2009 to 83 by August of 2010. These figures suggest that the improvement in the average diffusion index was geographically broad, likely a reflection of fewer layoffs nationwide, and not just strength in a handful of markets.

Those cities which experienced the broadest expansions through August are evident in the map chart. These markets are evenly spread across the country, but there are clusters in the Middle Atlantic (Washington, Baltimore, and Dover) as well as in South Carolina (Charleston-North Charleston, Columbia, and Florence), Illinois (Decatur, Danville, Peoria, Davenport-Moline-Rock Island, and Rockford), and in the Northern Midwest (Fargo, Sioux Falls, and Bismarck). Not surprising, some markets where construction was robust or where a large overhang of housing existed ranked near the bottom – such as Riverside-San Bernardino-Ontario, Sacramento-Arden-Arcade-Roseville, and Providence-New Bedford-Fall River. However, there were many markets – and geographically widespread – with low scores that were industrially diverse, Portland-Vancouver-Beaverton, San Francisco-Oakland-Fremont, and Little Rock-North Little Rock among them. Metros with broad-based economies and those with large shares of federal government employees and workers in education and health services tended to have higher scores. These two industries – federal government and education/health services were anchors for many markets and helped to stimulate employment in other industries as a result.

Going forward, those markets with high shares of employment in transportation and warehousing or manufacturing will improve as the economy expands. Manufacturing employment has already improved in a number of markets — many of which are clustered in the Midwest including Lansing-East Lansing, Youngstown, South Bend-Mishawaka, Cleveland-Elyria-Mentor, and Fort Wayne. Yakima and Kennewick-Richland-Pasco in the Northwestern and Dallas-Fort Worth-Arlington and Amarillo in Texas have also gained jobs in manufacturing. Improvements to shipping and warehousing will help markets like Memphis and Spartanburg.

A more general point can be made about the diffusion index during the expansion. Many manufacturers in America’s rust belt closed their doors and reopened production abroad during the recession of 2001 and 2002. Employment in the manufacturing sectors of many markets in Ohio, Indiana, New York, and Michigan suffered as a result. This trend caused the average diffusion index for the 159 markets covered to fall from near 70 during the expansion of the late 1990s to roughly 60 during the period from 2002 through 2006. Like the auto industry in the last recession, the construction industry and manufacturers who build products for construction will be sidelined for quite some time. As a result, the average diffusion index in the coming expansion will likely be lower than the average for the period of 2004 through 2006 as fewer industries will be able to contribute to growth of employment.

It is often said that “all real estate is local.” The same can be said for economies. As stated last month in this column, local markets will expand differently depending on their industrial makeup and their dependence on the construction and related industries for job growth. Demand for workers in the healthcare and education services will continue to grow in the long term, but a broader based recovery will remain a paramount goal for most local markets.

©National Association of Realtors® – Reprinted with permission