CHAPTER 4

ANALYZING
METROPOLITAN ECONOMIES

INTRODUCTION
MAIN ANALYSIS STEPS
1. Identification of Spatial Unit of Analysis
2. Analysis of Basic Growth Indicators
3. Analysis of Population Trends
4. Analysis of Sectoral-Employment, Income, and Industry-Structure Trends
5. Synthesis: Growth Prospects
CHAPTER SUMMARY
PROJECT #1: ANALYZING METROPOLITAN GROWTH PATTERNS
REFERENCES AND ADDITIONAL READINGS
APPENDIX 4A: ABOUT INDICES

INTRODUCTION

This chapter uses the case of Los Angeles to demonstrate a “broad-brush” analysis
framework that can be applied to the analysis of metropolitan real estate markets. It is
labeled as “broad-brush” analysis because it is based on broadly available data, and, as such,
it is limited in terms of the level of detail at which the different issues can be explored. More
detailed analysis would require the collection of additional information depending on the
growth regimes discussed earlier.
What should a section focusing on metropolitan-growth analysis include? Simple
descriptions of trends? Forecasts? Simple analysis of what’s happening in the area’s
employment, population, and income or something more? If there is any conclusion from the
discussion in the previous chapter is that simple description of trends is utterly insufficient in
shedding light on real estate demand growth prospects. One needs to also understand and the
reasons behind the historical and forecast movements in the major growth indicators in order
to better assess their implications for real estate demand.

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MAIN ANALYSIS STEPS

We look at metropolitan growth analysis as a series of methodological steps. The main

analysis elements include the following:

1. Identification of the Spatial Unit of Analysis

2. Analysis of Basic Growth Indicators
3. Analysis of Population and Income Trends
4. Analysis of Sectoral-Employment, Income, and Industry-Structure Trends
5. Synthesis: Growth Prospects

1. Identification of the Spatial Unit of Analysis

The first step of metropolitan growth analysis involves the definition of the area of
analysis. Metropolitan growth analysis focuses on economically integrated spatial units, that
is, areas within which economic activity at all locations is strongly influenced by the same
broader forces. Metropolitan Statistical Areas (MSAs) do represent integrated spatial units
from both an economic and a real estate point of view. An MSA is defined by the
Department of Commerce along the lines of county boundaries. It typically consists of one
central city, of at least 50,000 residents,
Figure 4.1 Example of a CMSA and one or more contiguous counties that
are metropolitan in character, as
determined by the percent of labor force
that is non-agricultural and the amount of
MSA commuting between city and county. As
MSA such, it represents an integrated labor
market and a unified area in terms of
PMSA
economic activity. Furthermore, it does
represent an integrated real estate market,
since commercial and residential
MSA properties located within its boundaries
MSA may compete amongst them, but not with
similar properties in non-adjacent
metropolitan areas.
Within this context, the typical
focus of metropolitan growth analysis is
the MSA within which the project under
consideration is located. If this MSA, however, is the Primary Metropolitan Statistical Area
(PMSA) of a Consolidated Metropolitan Statistical Area (CMSA) that consists of several
MSAs (see Figure 4.1), then a decision has to be made whether metropolitan growth analysis
needs to be extended to cover the whole CMSA. For example, in the case of Los Angeles the
options are to use the Los Angeles PMSA, which includes only Los Angeles county, or the
Los Angeles CMSA, which includes Orange county, Riverside county, San Bernardino
county and Ventura county, in addition to Los Angeles county. The CMSA may be a more
or less integrated economic unit in the Southern California region, but Los Angeles County

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appears to behave as a segmented market because of its high cost locations. So there are
trade offs involved when we deal with spatial unit identification. Ideally, both the specific
MSA under consideration and the CMSA it belongs to should be analyzed, in order to gain a
more complete perspective of the prospects of the local economy.

2. Analysis of Basic Growth Indicators

The second stage of metropolitan growth analysis focuses on the historical movements in
basic growth indicators, such as population, employment, and income (see Figure 4.2). The
objective of this effort is to identify first meaningful patterns and associations, and,
eventually, the underlying forces driving the local economy. This requires the following
specific steps:

1) Collect historical data and forecasts on population, employment, and income.

The cheapest historical employment and income data can be obtained from the U.S.
Government and, specifically, the Bureau of Economic Analysis (BEA). This
information is available on an annual basis since 1969. Population data can be
obtained from the Bureau of the Census. Under normal conditions, there is a 1-2 year
lag between the latest information published and the time of the release of the data.
More specifically, the employment and income data provided by BEA include:
Employment : Total non-agricultural employment and employment by major
industry
Income : Total personal income
Income from employment
Income from ownership of assets
Transfer income from the government

2) Identify periods with similar behavioral trends

3) Search for patterns of association

• Compare population and employment movements
• Examine labor force participation (LFP) movements
• Compare employment and income movements
• Examine movements in wages

4) Analyze/identify the underlying forces behind observed trends using supplementary

data

In order to more productively examine historical trends and patterns of association it is

better at this stage to deflate income figures (convert them into real dollars) and normalize
them on a per-worker basis. Graphing historical and forecast movements in real income per
worker, along with employment and population, as in Figure 4.2, can provide a better
understanding of their movements through time and facilitate a more meaningful
interpretation.

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 BOX 4.1 A BROAD-BRUSH ANALYSIS FRAMEWORK

The underlying premise of metropolitan growth analysis is that simple description of trends
is utterly insufficient in shedding light on real estate demand growth prospects. Both basic
trends-- in population, employment, and income--and the reasons behind the historical and
forecast movements in such growth indicators should be analyzed.

1. Identification of the Spatial Unit of Analysis

Metropolitan growth analysis focuses on economically integrated spatial units.
The typical unit of analysis is the Metropolitan Statistical Area (MSA) within which
the project is located, but in the case of Consolidated Metropolitan Statistical Areas
(CMSAs) that include several MSAs, the analyst needs to decide whether the analysis
should be extended to cover the whole CMSA.

2. Analysis of Basic Growth Indicators

Explore broad patterns of population, employment, and income growth, and try to
identify meaningful growth patterns and associations (see Figure 4.2).

3. Analysis of Population Trends

What are the primary components of population growth (internal growth, net
migration) and their characteristics (e.g., demographics and skill characteristics of
migrants)?
Population Identity:
Popt = Popt-1 (1 + Birth Rate - Death Rate) + Net Migration
 Net Migration = Popt - Popt-1 (1 + Birth Rate - Death Rate)
What are the primary forces behind positive or negative net immigration?
What role do regional incomes and regional amenities play in shaping population
growth? What are the future prospects with respect to the influence of these factors?

4. Analysis of Sectoral-Employment, Income, and Industry-Structure Trends

How have the various industry sectors been performing in terms of employment and
incomes, and how are they expected to perform? What are the area's key employ-
ment sectors? What has been driving and what will likely drive the performance of
these sectors?
A first-cut analysis involves simple examination of employment and income growth
patterns (Figure 4.3), absolute and relative employment shares (Figure 4.4 and Tables
4.1 and 4.2), and employment growth components (Table 4.3).

5. Synthesis: Growth Prospects

Develop a consistent story explaining past and future growth patterns and explore the
implications of such patterns for the long-term prospects in the marginal demand for
real estate product types.

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 When dealing with variables expressed in different units or differ greatly in magnitude,
such as income per worker and employment, it is much easier to plot them on the same graph
by converting them into indices. Appendix 4A provides a detailed discussion of indices and
how they should be constructed. It also elaborates on the Consumer Price Index (CPI) and
demonstrates how it can be used to deflate income figures.

Figure 4.2 Los Angeles MSA: Population, Employment and Real Income/Worker

170

160

150

140

130

120

110

100

90

80
1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005
Population Employment Real Income/Worker

Source: U.S. Department of Commerce, Bureau of Economic Analysis;Woods & Poole Economics

Figure 4.2 presents historical trends and forecasts for population, employment, and
real income per worker in the Los Angeles-Long Beach MSA (defined as the Los Angeles
County). Historical employment and income data cover the period 1969-1998, while
population data span over the period 1969-1999. As the figure shows, employment grew
considerably faster than both population and real income per worker. In particular, over the
period 1969-1998, employment grew by a cumulative 55%, while population grew by about
32% and real income per worker by 24%. The considerably greater employment growth,
compared to population growth, suggests increasing number of commuters from neighboring
counties and/or increasing labor force participation rates. Furthermore, the fact that real
income per worker increased at a considerably slower pace than employment suggests
demand-induced growth and an elastic labor supply. Such a growth pattern implies that Los
Angeles grew over the last 30 years considerably faster in terms of physical size than in
terms of wealth.
Focusing on employment, we can discern a different behavioral pattern in the 1990s
compared to the previous 20 years. In particular, between 1970 and 1990, it appears that
employment has been growing at a steady rate of about 2.2% (compounded rate), but after an
8% cumulative decrease in the early 1990s, it resumed growth at a somewhat slower pace.

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 The question looking ahead is whether this relative slowdown in employment growth
compared to the 1970s and the 1980s represents a short-term phenomenon or a secular trend.
Analysis of employment and income trends by industry in the next stage may shed light on
this question. A potential explanation for slower employment growth in the 1990s is
increased productivity, which may represent a secular trend. If this is the case, then the
slower employment growth observed in Los Angeles, as well as many other metropolitan
economies in the country during the 1990s, may represent a secular trend too. The Los
Angeles economy may return in the future to the higher employment growth rates of the
1970s and the 1980s under a higher productivity regime, if new economic forces foster a
faster demand growth rate for products and services produced by the local industries.
Historical population growth patterns seem to be clearly smoother and slower than
employment growth patterns. In particular, population seems to have followed a relatively
stable growth pattern between 1970 and 1990, but after 1990, it remained practically flat until
almost the end of the decade. In order to evaluate whether these trends will continue in the
future, more information needs to be collected in terms of the different sources of population
growth in the Los Angeles area during the 1990s. Such information will help distinguish
whether such slowdown was due to reduction in birth rates or a considerable reduction in net
migration, perhaps triggered by the introduction of legislation imposing further restrictions
on international migration. The latter explanation would suggest a considerably less elastic
labor supply in the 1990s, which may have been the cause of the somewhat slower
employment growth during that period. These are, however, just conjectures and further
investigation of these issues is needed to get a clearer idea of the underlying forces that have
been restraining population growth in the Los Angeles area recently, and whether they are
likely to continue in the future. Such analysis will also help more accurately identify patterns
of association between population growth and employment growth during the 1990s and
better assess the prospects of those patterns.
The long-term trend conveyed by Figure 4.1 regarding real income per worker in the
Los Angeles area is that it grew at a quite lower (but rather constant) rate compared to
employment. In terms of more recent trends, income per worker grew at a relatively fast
pace between 1998 and 1992, but remained practically flat between 1993 and 1997. The lack
of wage growth in the first half of the 1990s is most likely attributable to the recession and
declining or flat employment during that period. During the most recent period of 1995-
1998, real income per worker was growing at the very slow pace of 0.6%, which is half of
the pace it was growing in the 1980’s.

3. Analysis of Population Trends

At this stage, the analyst needs to examine the primary components of population growth and
their characteristics. In analyzing population trends, three important questions need to be
addressed:

1) Why and how is the population growing?

- Immigration?
- Natural growth?

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 The basic population identity below can help answer this question:

Popt = Popt-1 (1 + Birth Rate - Death Rate) + Net Migration (4.1)

If a net migration figure is not available from the state government, the planning
department, or other local government agency, which is very likely, then it can be
calculated as the residual using (4.2), if last year’s birth rates and death rates are known or
can be estimated:

Net Migration = Popt - Popt-1 (1 + Birth Rate - Death Rate) (4.2)

Obviously, for applying (4.2) the analyst needs data on population, births, and deaths.
Information on population can be obtained from current population reports and population
centers. Carn et. al. (1988) indicate that data on births and deaths may be available from
public records or can be estimated using fertility rates and death or survival rates.

2) What are the primary forces behind positive or negative net migration?

This is a difficult question to answer without direct data. The analyst needs to check with
local and state government agencies, local and state university research centers, or other
potential sources, if there is any existing study on this issue. If wages in the area are
increasing, it is likely that migration may be the result of growth. Examining what role
regional incomes and regional amenities play in shaping population growth may provide
some useful insights into the question of what are the primary drivers of immigration in
the area under consideration. Furthermore, assessing the future prospects of these factors
will help form an opinion as to whether observed immigration trends will continue in the
future. If data allow it, it may be useful to distinguish between international and domestic
migration.

3) If supply shifts are due to immigration, what are the demographics of the migrants and
what are their labor skills? Do they match local industry requirements?

Again, this is a difficult question to answer but some anecdotal evidence may exist from
university reports, newspapers, planning departments, local chambers of commerce, and
government associations, such as the Southern California Association of Governments
(SCAG). In the 1980s, for example, low-skilled workers were migrating to Los Angeles,
and this is perhaps why supply effects were not prevalent. Thus, addressing this question
can help gain a better understanding of why a certain type of growth did or did not occur.
Since market analysis is carried out in order to gain a perspective about what may happen
in the future, the analyst needs to consider throughout this exploration the likelihood of
the continuation of most recent population growth trends.

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4. Analysis of Sectoral-Employment, Income, and Industry-Structure Trends11

This stage of analysis can help identify which sectors contribute the most to the area’s
economy, and which ones have been growing faster recently in terms of employment and
earnings. The following questions need to be addressed in particular:

♦ How have the various industry sectors been performing in terms of employment and
incomes and how are they expected to perform in the future?
♦ What are the area's key employment sectors and industries?
♦ What has been driving and what will likely drive the performance of these sectors in the
future?

Answers to these questions will help further clarify what has been driving economic
expansion in the area and shed light on the type of growth that has been taking place. A first-
cut analysis involves a simple review of several statistics by sector, such as employment and
income growth patterns (Figure 4.3), absolute and relative employment shares (Figure 4.4
and Tables 4.1 and 4.2), and employment growth components (Table 4.3). Below we present
such a simple analysis for the Los Angeles metropolitan area.

Analyzing Employment and Income Growth Patterns by Industry

In order to answer the first question posed above we examine long-term historical trends and
medium-term forecasts for employment and earnings per worker for the major non-
agricultural sectors of the Los Angeles economy. These are presented in Figure 4.3 in which
the data from 1969 to 1998 represent history, while the data from 1999 to 2005 represent
forecast. Below we review these historical trends and forecasts by sector.

Construction As shown in Figure 4.3, Construction employment has been very volatile,
reflecting large swings in real estate building activity. For example, the 1975, 1982 and 1991
recessions, were followed by sharp decreases in Construction employment. It should be
noted that Construction employment reached extreme and highly unsustainable levels in
1989 and 1990, due to extraordinarily high commercial development activity. As a result, it
registered severe decreases in the early 1990s and by 1998 it was still below its 1990 level,
despite a few years of growth after 1994. Thus, on a cumulative basis Construction
employment declined during the period 1990-1998.
Real wages in the Construction sector followed a different and definitely less volatile
path than employment. As Figure 4.3 indicates, they hardly realized any gains in the 1980s
and have been declining most or the 1990s, when Construction employment was declining
rapidly from the heights it reached in the late 1980s. In 1997 real wages in the Construction
industry turned around and started rising slowly along with employment, signaling perhaps
the start of a new demand-induced growth cycle.

11
The terms sector and industry are interchangeable in the discussion that follows.

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Figure 4.3 Indexes of Sectoral-Employment and Earnings-per-Worker

Construction Finance, Insurance, Real Estate

190 230
210
170
190
150
170
130 150
110 130
110
90
90
70 70
50 50

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005
1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005
Construction Employm Earnings/Worker FIRE Employment Earnings/Worker

Manufacturing Services
130 350
120 300
110
250
100
90 200

80 150
70
100
60
50 50
1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005
1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

Manufacturing Employment Earnings/Worker Service Employment Earnings/Worker

Wholesale Trade Retail Trade

190 170

170 150
150 130
130
110
110
90
90
70 70

50 50
1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

Wholesale Trade Employment Earnings/Worker Retail Trade Employment Earnings/Worker

TCU Government
170 150
160
140
150
140 130
130 120
120 110
110
100
100
90 90
80 80
1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

TCU Employment Earnings/Worker Government Employment Earnings/Worker

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Finance, Insurance and Real Estate (FIRE) FIRE employment and Construction
employment tend to move together since a significant portion of employment in real estate is
associated with the development industry. As Figure 4.3 indicates, FIRE employment trends
in the Los Angeles area have been similar to those of Construction, but movements in the
former exhibit less pronounced fluctuations than in the latter. As was the case for
Construction employment, FIRE employment, after peaking in 1989-1990, was declining
until 1996, and resumed moderate growth during the subsequent two years. The decline in
FIRE employment in the Los Angeles MSA during the 1990s was to some extent a reflection
of the drastic reduction of real estate development activity, and the banking crisis, brought
about by the collapse of the real estate market at the beginning of the decade.
Real wages in the FIRE sector rose at a slower rate than employment did during the
1970s and the 1980s. In particular, during the 1970s, wages registered minimal real growth,
while fluctuating moderately. During the 1980s, however, they rose rather rapidly
registering an over-40% cumulative increase by 1987, when they reached their peak. After a
small drop during the period 1988-1990, they continued rising, while FIRE employment was
primarily declining. By 1998, the wage index rose to 187. The relatively strong real wage
growth in the 1980s and 1990s could be due to scarcity of high-skill labor and/or
restructuring of the industry.

Manufacturing Considerable fluctuations can be noted in the case of Manufacturing

employment and income. For example, in the 1980s, employment was rising, but wages
were roughly stable. In 1989, Manufacturing wages began a steep decline that stopped in
1995 after registering a 25% cumulative decrease. Echoing the effects of the national
recession, Manufacturing employment started declining four years later (in 1993), and
continued to do so until 1996. After 1996, both Manufacturing employment and wage
growth turned positive and remained so until 1998. These trends could be attributed to
demand effects, changes in labor-force composition, and productivity effects.12

Services Employment growth in the Service sector was spectacular and far outpaced the
growth in every other sector over the last thirty years. By 1998, Service employment in the
Los Angeles MSA had registered a 266% increase from its 1969 levels. It should be noted
that, with the exception of the 1991 economic downturn, Service employment continued to
grow at the same strong pace even when the national and the local economy were in a
recession.
Earnings per worker in the Service sector registered a consistent upward secular trend
with very slight fluctuations. They have been growing, however, at a very slow rate (only a
cumulative 25% over the 30-year period), which is in sharp contrast with the fast pace
employment in this sector has been growing. These trends point to a quite elastic supply of
labor in the Los Angeles Service sector.

Wholesale and Retail Trade Wholesale and Retail Trade employment in the Los Angeles
MSA registered similar growth patterns over the last thirty years. In particular, employment
in both sectors was steadily increasing at a relatively strong pace during the 1970s and the
1980s and declining in the early 1990s. From 1994 to 1998, employment has been rising, but
not as rapidly as before. In terms of wages, however, the two sectors registered different
12
It should be noted that output per worker is a much better indicator for productivity effects.

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trends. In particular, wages in the Wholesale Trade sector registered a very stable trend of
very slow growth over the last thirty years. On the contrary, wages in the Retail Trade sector
registered a secular trend of slow decline that was only interrupted during the period 1982-
1986 when they were noticeably increasing.

Government Employment in the Government sector includes persons employed by the

federal government (including the military) or state and local governments. As shown in
Figure 4.3, employment and wages in this sector have moved very closely over the 30-year
history examined. Although wages appear to have been somewhat more volatile, both
indicators have been rising in the 1970s and the 1980s. In the 1990s both indicators were
very slowly declining until 1996, but were rising in 1997 and 1998 (employment very slowly,
but wages rapidly in 1998).

Transportation Communications and Utilities (TCU) Employment in TCU remained

practically flat during most of the 1970s but registered rather rapid growth during the last
three years of the decade. During the 1980s and the 1990s, it was largely growing at a
moderate pace. This secular growth pattern was interrupted during the periods 1979-1984
and 1990-1992 when employment in TCU was declining as a result of the economic
recessions that took place during those times.
Real wages followed somewhat different trends. In particular, they were mostly
rising from 1969-1983, but declining most of the 1980s and the early 1990s. After 1992,
however, real earnings per worker resumed positive growth and kept rising until 1998.
These trends suggest demand-induced growth and elastic labor supply, during the 1970s and
the 1990s, and supply-induced growth during the 1980s, when employment was rising and
real wages were declining.

In sum, in terms of historical trends, all non-agricultural sectors, but Manufacturing,

have been largely growing during the 30-year period examined, but definitely at different
rates. The Service sector has demonstrated by far the most stable and strongest growth
pattern, which was only slightly interrupted by the 1991 recession, contrary to all other
sectors that were much more severely affected. Government and TCU employment grew at
the slowest rates, while Construction, Wholesale Trade, Retail Trade, and Manufacturing
employment were the most severely affected by the 1990-1991 recession. In terms of more
recent trends, employment in all sectors was declining in the early 1990s and in some sectors,
such as FIRE, it continued declining until 1996. By 1997, however, all sectors had returned
to positive growth.
Long-term trends in real earnings per worker leave little doubt about the high
elasticity of labor supply in the Los Angles area. In particular, real wages in all sectors, but
FIRE, registered very modest growth (Services, Government, TCU, Manufacturing, and
Wholesale Trade) or even declined (Retail Trade and Construction) over the 30-year period
examined. Overall, this historical analysis verifies that the prevalent growth pattern in
almost all sectors of the Los Angeles economy over the last three decades was that of
demand-induced growth within an environment of a fairly elastic labor supply.
Looking ahead, Woods & Poole Economics predict that the fastest growing sectors in
the first two years of the forecast (1999 and 2000) will be FIRE, Construction, TCU, and
Services. Growth in the first three sectors, however, is expected to slow down to almost zero

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in the subsequent five years. On the contrary, Service employment, continuing a 30-year
trend, is expected to keep growing at decent rates ranging between 1.4% and 1.6%.
Employment in Wholesale and Retail Trade is expected to be growing very slowly, at rates
well below 1% for most of the forecast period. Manufacturing employment is expected to be
declining at a very slow pace continuing a 20-year secular trend.
Real earnings per worker are expected to be rising the fastest in the FIRE sector,
mostly at rates ranging between 1.4% and 1.5%. In the Manufacturing and Service sectors
earnings per worker are expected to be growing at decent rates, ranging between 1% and
1.2%. Real wages in the Government, TCU, Construction, Retail Trade, and Wholesale
Trade sectors are expected to be growing quite slowly at rates well below 1%. With the
exception of Construction and Retail, these forecast wage trends represent continuation of
long-term trends that have persisted during the last three decades. In the case of Construction
and Retail Trade, the predicted slow rise in real wages represents a reversal of a secular trend
of mostly stable or declining real earnings per worker.
Overall, all sectors, except Manufacturing, are expected to contribute to some extent
to the area’s employment growth over the period 1999-2005, but the Service sector will
continue to be the major engine of growth in the Los Angeles metropolitan area. With the
exception of FIRE and Manufacturing, growth in real wages in all sectors is expected to be
clearly slower than employment growth. These anticipated developments point to the
continuation of a demand-induced growth within an elastic labor-supply environment. Such
a growth regime would imply some expansion of the area in terms of physical size
accompanied by a smaller increase in wealth.

Analyzing Absolute and Relative Employment Shares

Analysis of the absolute and relative employment shares of the different economic sectors
can help answer the second question pertaining to the area’s key employment sectors. Such
analysis can in particular provide very useful insights with respect to the diversity or
specialization of an economy and the major drivers of local employment growth. As such, it
can help better assess the prospects the local economy and gain a perspective of how it may
perform in the future.
Absolute employment shares refer to the simple ratio of employment in a given sector
over the area’s total employment. The most common measure of relative employment
composition is the so-called location quotient and refers to the ratio of a sector’s absolute
share over the share of the same sector within a larger economic area, such as a region or the
nation.
We first focus on absolute employment shares in order to identify which sectors
contribute currently the most to the local economy, and whether any structural changes have
taken place over the longer-term. Table 4.1 presents the shares for each of the major six
sectors as a percent of total non-agricultural employment. As this table indicates, Services,
with an employment share of 38%, was by far the sector with the greatest contribution to the
Los Angeles economy as of 1998. Retail Trade, Government, and Manufacturing followed
with considerably smaller contribution ranging between 10% and 14%. The sector with the
smallest employment share of 3.7% was Construction.

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Table 4.1 Absolute Employment Shares in the Los Angeles Economy

Sector 1970 1980 1990 1998 2005

Construction 3.8% 3.5% 3.9% 3.7% 3.6%

Manufacturing 24.4% 21.7% 16.6% 13.3% 12.2%
Transportation, Communications
and Utilities 5.4% 4.9% 4.7% 5.1% 5.2%
Wholesale Trade 6.2% 6.6% 6.3% 5.8% 5.6%
Retail Trade 15.4% 15.0% 14.7% 14.6% 14.1%
FIRE 8.3% 8.8% 8.9% 8.1% 8.3%
Services 22.6% 26.7% 33.3% 37.8% 39.5%
Government 13.1% 11.7% 10.7% 10.6% 10.5%

Source: Estimated based on data provided by the U.S. Department of Commerce, Bureau of Economic
Analysis; Woods & Poole Economics.

Figure 4.4 presents the secular trends in employment shares, which do reveal some
structural transformations in the make up of the Los Angeles economy over the last 30 years.
As this figure shows, the shares of all sectors, but Services and Manufacturing, have been
very stable over the last three decades, registering very small deviations from their 1998
levels. Obviously, the prominent transformation that has been taking place in the Los
Angeles economy (and most of the country for that matter) is the considerable increase of the
importance of Services and the decrease of the contribution of Manufacturing. In particular,
the Manufacturing-employment share decreased steadily from 26.3% in 1969 to 13% in
1999, while the Service-employment share increased from 22% in 1969 to 38% in 1999.
Woods & Poole Economics predicts that these solid secular trends will continue
during the period 1999-2005. Thus, the Service-employment share is expected to increase to
39.5% by 2005, the Manufacturing-employment share is expected to decrease to 12.2%, and
the shares of the other sectors are expected to remain roughly at their 1998 levels.
The analysis of the absolute employment shares has provided some very interesting
insights with respect to the contribution of the major industries to the area’s employment
base. The analysis of relative employment shares, more typically referred to as location
quotients, can shed light on how the local economy compares to a larger economy, such as
the broader region within which is located (the Western region, in the case of Los Angeles)
or the nation. Such a comparison may highlight important structural differences and help
identify industries that are more or less influential to the local economy than they are to the
larger economy. The rationale behind the concept of the location quotient and its potential
interpretation are discussed in more detail in the next section.

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 2005 2005 2005 2005
2002 2002 2002 2002
1999 1999 1999 1999
FINANCE, INSURANCE, REAL ESTATE

1996 1996 1996 1996

Fi gure 4.4 Los A ngel es Sectoral Empl oyment Shares: Trends and Forecasts

1993 1993 1993 1993

RETAIL TRADE

GOVERNMENT
1990 1990 1990 1990
SERVICES

1987 1987 1987 1987

1984 1984 1984 1984
1981 1981 1981 1981
1978 1978 1978 1978
1975 1975 1975 1975
1972 1972 1972 1972
1969 1969 1969 1969

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45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%

45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
2005 2005 2005 2005
2002 2002 2002 2002
1999 1999 1999 1999
1996 1996 1996 1996
1993 1993 1993 1993

WHOLESALE TRADE
MANUFACTURING
CONSTRUCTION

1990 1990 1990 1990

1987 1987 1987 1987

TCU
1984 1984 1984 1984
1981 1981 1981 1981
1978 1978 1978 1978
1975 1975 1975 1975
1972 1972 1972 1972
1969 1969 1969 1969

45%
40%
35%
30%
25%
20%
15%
10%
5%
0%

45%
40%
35%
30%
25%
20%
15%
10%
5%
0%

45%
40%
35%
30%
25%
20%
15%
10%
5%
0%

45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Location Quotient: Origins of the Idea and Definition

The idea of the location quotient originated in the traditional economic base theory of
growth. According to this line of thought, an area’s economy is structured around two
sectors:

1. export or basic sector , which comprises industries exporting their products outside of
metropolitan boundaries, and

2. local or non-basic sector, which comprises industries supporting local demand

The prevalent thought was that the export sector is vital for the growth of the local
economy in the sense that increases in exports trigger increases in basic employment, which
in turn stimulate increases in the demand for local goods and increases in local-sector
employment. A multiplier effect is thus assumed to take place with increases in the demand
for the products produced by the area’s export industries inducing a series of economic
events that enhance local employment and income.
Within this framework, a typical task encountered in the analysis of a metropolitan
economy was the identification of its export industries. Hence, the concept of the location
quotient was born. The location quotient is a measure of the location concentration of an
industry within a given area relative to a larger economy. The formula for calculating a
location quotient using the nation as the reference economy is as follows:

 Eimetro 
 
 E metro 
LQimetro =  
(4.3)
 Eination 
 
E nation 
 
where:
LQ imetro : location quotient for industry i in metropolitan area m
Eimetro : employment in industry i in metropolitan area m
E metro : total employment in metropolitan area m
Eination : national employment in industry i
E nation : total national employment

Within the context of the economic base theory, the traditional interpretation of the
location quotient is as follows:

LQi > 1 signifies a basic industry, and

LQi < 1 signifies a local or non-basic industry

Such an interpretation, however, may be inaccurate because local consumption and

production patterns may differ across markets, dictating different labor requirements. Thus,
many scholars in the field, including the author, accept location quotient not as a means of
differentiating between basic and nonbasic industries but as a measure of relative industry

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concentration or industry importance. A location quotient greater than 1 simply means that
the industry in the area under consideration has greater concentration than at the national
level, and may signify its greater role in the local economy (depending on its share of total
local employment). Such concentration may be attributable to export demand due to
competitive advantages, local consumption patterns shaped by the area’s demographics,
and/or local production patterns shaped by the quality of the area’s labor force.

Relative Employment Shares in the Los Angeles Economy

Table 4.2 traces the longer-term trends in the location quotients for the major non-
agricultural sectors in the Los Angeles economy. These location quotients have been
calculated using the national economy as reference. It should be noted at the outset that a
declining location quotient does not necessarily imply a declining share of the sector under
consideration in the local economy. Such a trend, for example, could be the result of a
constant sectoral share in the local economy and an increasing share of the same sector in the
national economy.

Table 4.2 Location Quotients for the Los Angeles Economy

Non-Agricultural Sectors 1970 1980 1990 1998 2005

Construction 0.75 0.69 0.73 0.66 0.62

Manufacturing 1.08 1.15 1.15 1.07 1.09
Transportation, Communications
and Utilities 0.97 0.96 0.97 1.04 1.06
Wholesale Trade 1.29 1.27 1.29 1.23 1.20
Retail Trade 0.98 0.92 0.87 0.87 0.86
FIRE 1.18 1.12 1.14 1.03 1.03
Services 1.16 1.18 1.17 1.19 1.18
Government 0.71 0.69 0.69 0.76 0.77
Source: Estimated based on data provided by the U.S. Department of Commerce, Bureau of Economic
Analysis; Woods & Poole Economics.

As Table 4.2 indicates, during the period 1970-1990, the share of Manufacturing,
Wholesale Trade, FIRE, and Services in the Los Angeles employment base was higher than
the share of the same sectors in the national economy. The above-one location quotients for
these sectors, and especially, for Wholesale Trade, may be indicative of some specialization
of the local economy in these industries during that period. During the 1990s, the location
quotient for Wholesale Trade and Services has remained well above one, indicating the
continuing specialization of the Los Angeles economy in these two sectors. The location
quotients for Manufacturing and, especially, for FIRE, however, decreased closer to one by
1998, indicating the decreasing concentration of employment in these industries relative to
the nation.

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 Contrary to the aforementioned four sectors, whose importance in the Los Angeles
employment base was greater compared to the nation, the contribution of the Construction
and Government sectors to the local economy has been steadily and noticeably lower than
their contribution to the national economy. The location quotients of these two sectors have
been ranging steadily between 0.65 and 0.75 over the period 1970-1998. The same
conclusion, but to a lesser extent, applies to Retail Trade after 1982, when its location
quotient fell below 0.90. Finally, the location quotient for TCU has been hovering very close
to one since 1969, indicating a similar contribution of the sector to the Los Angeles
employment base as in the nation.
In sum, as of 1998, it seems that only Wholesale Trade and Services were noticeably
over-represented in the Los Angeles economy compared to the national economy, while
Government, Retail Trade, and Construction were considerably under-represented.
A note of caution should be added here. For a more accurate interpretation of what
these location quotients mean one needs to look at them in conjunction with absolute
employment shares. For example, the fact that Wholesale Trade had the highest location
quotient (1.23) in 1998 does not mean that it is also the most important industry for the Los
Angeles economy. In fact, with employment in this sector accounting for only 5.6% of the
area’s total non-agricultural employment in 1998, its importance is highly questionable (see
Table 4.1). On the other hand, the fact that the Service industry had the second highest
above-one location quotient reinforces the conclusion regarding its importance for the local
economy, as suggested by its very high absolute employment share.

Shift-Share Analysis

The review of historical and forecast data suggests that nearly all sectors in the Los Angeles
metropolitan area have been growing since the early or mid-1990s and are expected to
continue to grow in terms of employment, but at rates considerably lower than those
registered in the 1980s. In reviewing these historical growth patterns, the analyst needs to
address the following questions:
• Is a sector in the local economy growing because the overall national economy
is doing well?
• Is it because specific sectors/industries are doing well at the national level?
• Or is it because of idiosyncratic features and productive advantages of the
metropolitan economy?

We can address these questions using shift-share analysis. It should be emphasized

that this technique is purely used for analysis of historical data, not forecasting. It only offers
a glimpse at the localized or broader nature of the forces that may drive the local economy.
Thus, a more detailed analysis of historical trends in the key industries and the specific
factors that drive them is needed in order to shed more light on their future prospects.
Information provided by studies that may be available at local universities, local Chambers of
Commerce, and/or Economic Development agencies, may provide useful inputs for such an
analysis. Again, the ultimate objective is to gain a better understanding of the prospects for
increases in an area’s output, which, in combination with an understanding of local labor-
supply dynamics, may provide insights regarding the type of growth that will be taking place
in the area.

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 According to the shift-share analysis framework, employment growth in a
metropolitan area during a given period can be decomposed into three components:

♦ Share Effect
Indicates by how much industry i would have grown if it grew at the same rate
as all industries at the national level
♦ Industry Effect
Indicates the additional growth a metropolitan area is experiencing due to its
particular industry mix. For example, local growth rates should be higher than
national growth rates if faster-growing industries are over-represented in the
metropolitan economy compared to the national economy.
♦ Competitive Effect
Indicates the additional growth a metropolitan area’s industries may be
experiencing due (perhaps) to competitive metropolitan location factors. For
example, specific sectors at the metropolitan level may be growing faster than
at the national level, due to the area’s competitive advantages.

Decomposing employment growth in this way may reveal more information about the
strength of a particular industry and its prospects perhaps for growth. For example, let’s look
at the shift-share analysis of the employment growth that took place in the Los Angeles
metropolitan area during the period 1990-1998 (see Table 4.3). During that period national
employment grew at a cumulative rate of 15%, while employment in the Los Angeles area
decreased by about 1%. So clearly, the Los Angeles economy performed considerably worse
than the national economy.
Shift-share analysis reveals that if every sector in the Los Angeles economy grew at
the same rate as the national economy did (15.3%), 812,700 new jobs would have been added
in the area’s employment base during the period 1990-1998 (see Share Component in Table
4.3). Instead, 49,000 jobs were lost. As Table 4.3 indicates, all sectors, but Services and
TCU, lost jobs during the period of analysis. Service jobs grew by 226,600, representing a
12.7% increase over their 1990 level, while TCU jobs grew by 21,100, representing an
increase of 8.5%.
The industry-effect analysis indicates that an additional 41,100 jobs would be gained
(on top of the 812,700) if each sector in the Los Angeles economy grew at the same rate as it
grew at the national level. The net gain in jobs over the Component Share suggests that some
of the fastest growing sectors at the national level, such as Services, FIRE, TCU, and
Construction, are over-represented in the Los Angeles economy compared to the nation. As
the location-quotient analysis has shown, among these four industries, only Services had a
location quotient noticeably greater than one during the period 1990-1998 (see Table 4.2).
Therefore, most of the net gain in jobs reflected in the Industry Effect would be due to
growth in the Service sector. Finally, the Competitive Effect estimates convey very bad
news for the Los Angeles economy. This effect is negative across all sectors suggesting that,
during the period 1990-1998, the Los Angeles economy was plagued by broader competitive
disadvantages that affected all its industries. A more detailed analysis is needed in order to
identify the nature of these competitive disadvantages and evaluate whether they will persist
into the future.

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Table 4.3 Los Angeles Metropolitan Area: Shift-Share Analysis, 1990-1998
Metropolitan Share
Metropolitan Metropolitan Employment Metropolitan National Component Shift Components
Employment Employment Change Growth Growth Industry Competitive
1990 1998 1990-1998 Rate Rate Effect Effect
Nonagricultural Sectors (thousands) (thousands) (thousands) 1990-1998 1990-1998 (thousands) (thousands) (thousands) Total

Construction 208.9 194.7 -14.2 -6.8% 21.2% 32.0 12.3 -58.5 -14.2
Manufacturing 885.4 703.0 -182.3 -20.6% -1.0% 135.7 -144.2 -173.8 -182.3
Transportation, Communications, and Utilities 249.1 270.2 21.1 8.5% 17.4% 38.2 5.2 -22.3 21.1
Wholesale Trade 339.2 308.1 -31.2 -9.2% 10.1% 52.0 -17.7 -65.5 -31.2
Retail Trade 785.5 773.4 -12.1 -1.5% 14.9% 120.4 -3.6 -129.0 -12.1
Finance, Insurance, and Real Estate (FIRE) 477.8 431.8 -46.0 -9.6% 16.3% 73.3 4.5 -123.7 -46.0
Services 1,781.1 2,007.7 226.6 12.7% 29.4% 273.1 251.3 -297.8 226.6
Government 573.7 562.9 -10.8 -1.9% 3.7% 88.0 -66.6 -32.2 -10.8
TOTAL 5,300.9 5,251.9 -49.0 -0.9% 15.3% 812.7 41.1 -902.8 -49.0

Shift-Share Analysis Formula

Σ E i metro g i metro =[ Σ i E i metro g nation ] + [ Σ i E i metro (g i nation -g nation )]+ [ Σ i E i metro (g i metro -g i nation )]

Total Share Component Total Industry Effect Total Competitive Effect

Shift Components
where:
metro
Ei Employment in industry i in a given metropolitan area
metro
gi Employment growth rate in industry i in a given metropolitan area
nation
gi Employment growth rate in industry i in the nation
nation
g Total employment growth rate in the nation

5. Synthesis: Growth Prospects

In the synthesis stage, the analyst needs to develop a consistent story explaining past and
predicted growth patterns and explore their implications regarding the long-term prospects
for growth in demand for real estate product types. From Figure 4.1 one can identify distinct
periods in the area’s economy with similar trends. Thus, for the purposes of presenting this
example we will examine relevant metropolitan-growth statistics for four periods: 1970s,
1980s, the 1990-1993 recession, and the post-recession period.
Table 4.4 presents relevant metropolitan growth statistics for the Los Angeles area
during the 1970s (1972-1981). As we can see from this table, employment during that period
was rising faster than population and nonfarm employment was rising somewhat faster than
nonfarm income. As a result, nonfarm income per worker decreased slightly at the average
annual rate of 0.1%. These statistics point primarily to labor supply shifts and an elastic
product demand, resulting in increases in employment and slight decreases in wages.

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TABLE 4.4 Synthesis: Metropolitan Growth Patterns During the Seventies

#1
1970s Basic Statistics Prevailing Growth Forces
(1972-1981) Average Annual Rates of Change Supply-side

Worker supply Population 0.84%

shifts in light of Total Employment 2.80%
elastic Nonfarm Employment 2.80%
product Labor Force Participation 1.94% LFP Amenity-
demands Total Nonfarm Income 2.67% Baby induced LFP
Nonfarm Income/Worker -0.13% Boom immigration Women

Notes:
Employment rises faster than population
Nonfarm employment rises faster than nofarm income

Labor supply in the Los Angeles area increased due to amenity-induced immigration
from other regions/countries and due to increases in LFP. Increases in the latter are
attributable to baby boomers entering the labor force, as well as increased participation of
women. The faster increase in employment compared to the population may be attributed to
some extent, in addition to the increased LFP, to commuters living in the neighboring
metropolitan areas of Orange county, Ventura, and Riverside-San Bernardino. Observed
increases in housing prices during that period can be attributed to a combination of factors.
These include greater demand due to increases in the area’s employment and population,
demographics and specifically the entrance of baby-boomers in the housing market,
expectations of continuing housing price increases, and, perhaps, an inelastic housing supply
due to growth regulations.
Table 4.5 presents metropolitan growth statistics for the second period of analysis,
that is the 1980s, and specifically from 1982 to 1989. As this table indicates, during this
period both employment and real wages increased in the Los Angeles metropolitan area. In
particular, employment increased faster than population and nonfarm income increased faster
than employment. As a result of these developments, average nonfarm income per worker
increased by 1.2%. These statistics then point to product demand shifts in the face of elastic
labor supply.

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TABLE 4.5 Synthesis: Metropolitan Growth Patterns During the Eighties

#2
1980s Basic Statistics Prevailing Growth Forces
(1982-1989) Average Annual Rates of Change Demand-side

Product Population 1.83%

demand shifts Total Employment 2.39%
in light of Nonfarm Employment 2.39%
elastic labor Labor Force Participation 0.56% Defense Trade/
supply Total Nonfarm Income 3.65% Spending Services
Nonfarm Income/Worker 1.24%

Notes:
Employment rises faster than population
Nonfarm income rises faster than nofarm employment
Los Angeles experienced significant immigration of mostly low-skill workers

The major drivers of increases in product demand during that period were defense
spending that funneled huge amounts of money to the Los Angeles metropolitan area,
increased demand for electronics, trade, and services. On the supply side, international and
domestic immigration in the area continued during the 1980s. Some of this migration was
amenity-induced contributing to labor-supply shifts, while some of it was due to the growth
taking place in the area, thus contributing to a more elastic labor supply. It should be noted
that most of the international migrants had low-skills and, therefore, if there were any shift in
labor supply that would affect only a few sectors of the economy. The increased demand for
the area’s services is very well reflected in the early 1980’s in a 40% cumulative increase in
average office-space rents, which triggered excessive overbuilding in the subsequent years.
Table 4.6 presents similar statistics for the period 1990-1993, during which the Los
Angeles economy was hit by the recession as most of the nation’s metropolitan areas. This
recession, however, lasted somewhat longer in Los Angeles. As the statistics show, during
that period, all indicators, but population and real wages, decreased. The increase in average
income per worker is misleading and it is simply the result of the fact that employment
decreased faster than total earnings. It does not really imply anything positive, since the
overall income in the economy decreased considerably at an average annual rate of 1.4%.

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TABLE 4.6 Synthesis: Metropolitan Growth Patterns During 1990-1993

#3 Basic Statistics
Recession Average Annual Rates of Change

1990-1993 Population 0.76%

Total Employment -1.71%
Nonfarm Employment -1.70%
Labor Force Participation -2.46%
Total Nonfarm Income -1.35%
Nonfarm Income/Worker 0.37%

Notes:
INCOME CHANGES ARE MISLEADING

Table 4.7 presents metropolitan growth statistics for the post-recession years (1994-
1998). During that period both employment and average nonfarm income per worker
increased at a moderate pace, suggesting again increases in product demand in the face of
elastic labor supply, or in other words, demand-induced growth. Domestic sources of growth
in product demand during that period include the entertainment, service, and high-tech
sectors. International trade growth and tourism contributed also to increases in the demand
for the area’s products. Some negative effects that served to moderate the demand increases
were the downsizing that took place in the defense and FIRE sectors. The labor supply
forces that were most likely at work during this period include, stabilization of the LFP, the
aging of the baby boomers (and their anticipated exit from the labor force), and negative
migration. The latter may be attributable to barriers to international immigration and
pessimistic job growth expectations that may have contributed to out-migration of
employable population. Although such forces do not contribute to an elastic labor supply, it
seems that labor supply in Los Angeles County was elastic enough to help companies avoid
raising wages a lot in order to attract workers.
Forecasts obtained from Woods & Poole Economics seem to suggest that the forces
that prevailed during the late 1990s (causing modest economic growth in the Los Angeles
area) are not likely to be reversed in the medium term. In particular, this forecasting firm
predicts that the area’s employment will continue growing during the period 1999-2005, but
at an even slower pace than it did recently. The rationale for this slow growth rate is that the
Los Angeles area is characterized by high employment and population densities, as well as
high living and land costs, which will divert new employment growth to the less dense and
cheaper neighboring counties, such as Riverside, San Bernardino, and Ventura.

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TABLE 4.7 Synthesis: Metropolitan Growth Patterns During the Post-Recession Years

Post-
Recession
Period Basic Statistics Demand Supply
(1994-1998) Average Annual Rates of Change Forces Forces

Product Population 0.35% Entertainment, Although still

demand shifts Total Employment 1.50% Service, higher than the
in light of Nonfarm Employment 1.50% High-tech national rate,
elastic labor LFP 1.14% Industry Demand fertility rates have
supply Total Nonfarm Income 1.94% Shifts been decreasing
Nonfarm Income/Worker 0.43% (a recessionary effect)

International Trade LFP stabilized,

Growth (largest but new welfare laws
exports: microchips; may have an impact
computers; aerospace)

Tourism Baby boomers

are aging and will
soon be exiting
the workforce

Defense, F.I.R.E. Negative net migration

Industry Barriers to international
Downsizing immigration
Low job growth
expectations

The predicted growth pattern by Woods & Poole Economics suggests that the Los
Angeles area will experience a moderate growth in physical size and a very small increase in
wealth over the period 1999-2005. Such developments should generate moderate growth in
the demand for residential and commercial real estate of mostly average quality.

Selected Sources of Information for Historical Data and Forecasts

Sources of metropolitan-level historical data and/or forecasts include:

BEA, Bureau of Economic Analysis, U.S. Department of Commerce
Economy.Com, West Chester, PA, 19382
Global Insight (Former DRI and WEFA), Waltham, MA, 02451
Woods & Poole Economics, Washington, D.C., 20009

Additional potential sources for such information include studies/research reports

prepared at universities, local Chambers of Commerce, planning departments, and other
government-agency research divisions. See other data sources in Clapp, John M. (1987).
Handbook for Real Estate Market Analyses. Englewood Cliffs, NJ: Prentice Hall.

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CHAPTER SUMMARY

In this chapter, we have discussed the basic steps of a broad-brush metropolitan-growth

analysis process and presented its application to the Los Angeles metropolitan area. This
process includes five basic steps:
• Identification of the spatial unit of analysis
• Analysis of basic growth indicators
• Analysis of population and income trends
• Analysis of sectoral-employment, incomes, and industry-structure trends
• Synthesis

The ultimate goal of this analysis is to understand the broader patterns of growth that
the metropolitan area under consideration will be experiencing in the years ahead, and their
broader implications for real estate demand. For example, broad-brush analysis of the Los
Angeles metropolitan area showed that after the 1990-1993 recession the area has been
experiencing a demand-induced growth, with employment increasing at a moderate pace, but
nevertheless, faster than real wages. According to Woods & Poole Economics, such demand
forces are expected to continue operating in the medium-term. They are expected, however,
to produce somewhat lower employment growth rates compared to the late 1990s, as growth
is very likely to be diverted to adjacent counties with lower densities, land costs, and living
costs.

QUESTIONS

1. A company specializing in the development of speculative high-end retail space is

currently in search of metropolitan areas whose growth patterns will likely be conducive to
such a development. The company has obtained information on two metropolitan areas,
whose employment growth over the next five years is expected to amount to 100,000
workers. The data suggest that the two areas' current average incomes (adjusted for living
costs) are at about the same level; that their income-distribution profile is very similar; and
that their existing supply of high-end retail space is just sufficient to satisfy current demand.
In addition, the following information was gathered regarding each area's economic base,
migration trends, and future prospects.

Metropolitan area A's economy is largely based on a growing number of high-technology,

information-based industries (e.g. computer software). Information obtained from the local
Chamber of Commerce suggests that prospects for further industry growth are excellent, as
foreign sales of those industries' products are expected to increase substantially over the next
five-years. Such growth is likely to be facilitated by local government support, including the
provision of incubator facilities for new firms, a host of cultural and other amenities, and the
area's high-end residential neighborhoods likely to suit the preferences of the location-
selective, highly-skilled workforce employed by the area’s high-tech industries. These high-
skill workers are drawn both from local universities and from adjacent metropolitan areas
with prestigious science and technology programs. Notably, amenity-induced immigration of

- 107 -
workers in this area is rather small, due to its cold climate and perceptions for high living
costs.

Metropolitan area B's economy is based on trade, service, and entertainment sectors that are
characterized by relatively price elastic product and labor demands. Given the area's
strategic location and quality of infrastructure, its growth is likely to continue being fueled by
non-negligible expansion in those sectors' output. Furthermore, the area's amenities and
expectations for further growth are likely to continue inducing sizable immigration of
appropriately skilled workers. The latter are expected to continue being attracted from two
neighboring metropolitan areas whose growth outlook seems to be rather dim.

(i) What type(s) of growth is each metropolitan area likely to experience in the coming
years? What will the dominant features of this growth be? Explain clearly your
answer.

(ii) Which of the two metropolitan areas seems to have better prospects for developing
speculative high-end retail space? Explain clearly your answer. If your answer is
conditional, again, be sure to explain.

PROJECT #1: ANALYZING METROPOLITAN GROWTH PATTERNS

The purpose of this exercise is to sharpen the skills of the students in describing broad
patterns of metropolitan growth, interpreting meaningfully such patterns, and exploring their
implications for long-term real estate demand prospects.

Data to be Provided by Instructor

Historical and forecast data on population, employment, and earnings by one-digit SIC
sector, for at least five metropolitan markets.

Main Tasks
Preparation of a brief essay (5-10 double-spaced pages) on the results of a broad-brush
analysis of metropolitan growth patterns in one of the metropolitan areas for which historical
and forecast data have been provided. The students are asked to follow the suggested
structure and the accompanying instructions below.

1. Introduction
As an introduction to the essay, the importance and role of metropolitan growth analysis
should be discussed in 1-2 paragraphs. The introduction should also indicate which area
was chosen and lay out the structure of the report, presenting briefly the contents of its
various sections.

II. Analyzing Metropolitan Growth Patterns

Using the data provided by the instructor, the students should discuss historical and
forecast patterns of growth in the metropolitan area they have chosen to analyze. More
specifically:

- 108 -
 (a) First, use summary growth indicators (indices of population, total non-agricultural
employment, and inflation-adjusted nonagricultural earnings per worker) to examine
the overall historical and forecast growth patterns in the metropolitan area in
question. Provide a brief but thoughtful discussion of such patterns, supplemented
with supporting summary data in tables and/or graphs.

(b) Second, examine growth indicators by one-digit SIC sector (indices of non-
agricultural employment and inflation-adjusted earnings per worker by economic
sector). Again, provide a brief discussion of your analysis, supplemented with
appropriate summary data.

(c) Third, using available sectoral data at the national level, provide a relatively more
detailed analysis of metropolitan sectoral employment. To this end, you can look (i)
at the degree of spatial concentration of broad economic sectors using location
quotient analysis and (ii) the main growth components of these sectors in selected
time periods using shift-share analysis. Again, supplement your discussion with
summary tables.

(d) Given your analysis in (a)-(c), what (preliminary) conclusions, if any, can you draw
in terms of the forces that underlie the observed and forecast metropolitan growth
patterns? Are the forces that have generated growth in the eighties and nineties
likely to continue operating in the next five years or so? Explain.

Note that you are always welcome (in fact encouraged) to refer to other, more
detailed information you consider important to collect in order to better address any
of the questions posed above.

III. Growth Prospects and Real Estate Markets

Lastly, in the concluding section of your essay, explore the implications of your
analysis for real estate development prospects in the metropolitan area under question
over the next five to ten years.

REFERENCES AND ADDITIONAL READINGS

DiPasquale, D. and W. Wheaton. 1996. Economic Growth and Metropolitan Real Estate
Markets. Chap. 7 in Urban Economics and Real Estate Markets. Englewood Cliffs, NJ:
Prentice-Hall, Inc.

Carn, N., J. Rabianski, R. Racster, and M. Seldin. 1988. Analyzing the Local Economic
Environment. Chap. 3 in Real Estate Market Analysis: Techniques and Applications.
Englewood Cliffs, NJ: Prentice-Hall.

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APPENDIX 4A

ABOUT INDICES

Sometimes it is very insightful to view several economic data series on the same graph. This
often facilitates a more meaningful interpretation of historical trends and forecasts. As
indicated earlier, however, when different variables are expressed in different units, or when
they differ greatly in magnitude, it is very convenient to convert the data into indices before
displaying them on the same graph.

1. What’s an Index?

An index is a numerical series that describes the movements of a variable through time.
These movements are measured with respect to a base period during which the index is set to
100. The example in Table 4A.1, presenting a population index for Los Angeles, illustrates
how indices in general should be interpreted. As this table demonstrates, percent changes are
measured with respect to the base year, which typically is the first year of the series (1969 in
this case). For example, the 1972 index value of 103.4 implies that population between 1969
and 1972 increased by 3.4%. Similarly, the 1995 index value of 156.1 implies that over the
period 1969-1995 population increased by 56.1%.

Table 4A.1 Los Angeles Population Index and Interpretation

Year Population Index Interpretation

1969 100.0
1970 101.6 1969-1970 : 1.6% increase
1971 103.0 1969-1971 : 3.0% increase
1972. 103.4 1969-1972 : 3.4% increase
..
1995 156.1 1969-1995 : 56.1% increase

2. How is the Index Calculated?

The index is calculated by simply dividing each of the numbers in the series with the base-
year number and then multiplying the result by 100. Table 4A.2 presents the formula and
demonstrates how it was used to calculate the population index presented in Table 4A.1.

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 Table 4A.2 Calculating the Los Angeles Population Index

Population Population Index

Year Index (In Thousands) Calculation

1969 100.0 9,858.7 9,858.7*100

9,858.7
1970 101.6 10,014.8 10,014.8*100
9,858.7
1971 103.0 10,156.6 10,156.6*100
9,858.7
1972 103.4 10,192.3 10,192.3*100
. . . 9,858.7
. . . .
. . . .
1995 156.1 15,392.3 15,392.3*100
9,858.7

3. Index Comparisons

In order to provide an example of how indices can help plot variables of markedly different
levels and/or units on the same graph, we plot the index for total employment and total real
earnings for a hypothetical market in Figure 4A.1. Table 4A.3 presents the numbers that
were used to produce the graph. The graph provides immediately a very clear picture of how
movements in these two variables compare through time. In particular, it is obvious from the
graph that income in the market under consideration was rising faster than employment in
1970 and 1972. This suggests that during those two years earnings per worker were
increasing, indicating a positive wealth effect, which is consistent with a demand-induced
metropolitan growth pattern.

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Table 4A.3 Index Comparisons Figure 4A.1 Index Comparisons

Total 106

Employment Real Earnings 105

Year Index Index 104

103
102
1969 100.0 100.0 101
100
1970 99.8 100.3 99
98
1971 98.9 98.8 97
1969 1970 1971 1972
1972 102.6 105.1
Employment Index Total Real Earnings Index

ABOUT THE CONSUMER PRICE INDEX (CPI) AND INCOME

Income figures are often provided in nominal terms. In such a case, they need to be adjusted
to take into account general price inflation, that is, converted into real income. Such an
adjustment is needed because in numerous economic applications in several fields, including
real estate, it has been found that economic behavior is driven by movements in real income,
not nominal income. This is understandable since general price inflation diminishes
purchasing power, which is the underlying driver of consumer spending behavior. For
example, a dollar in 1969 is not equivalent to a dollar today in terms of purchasing power.
A consumer could buy much more with a dollar in 1969 than a consumer can buy today with
the same amount because the prices of all goods have increased considerably between 1969
and today. Thus, nominal income figures have to be converted into figures reflecting
“constant purchasing power”, i.e., constant dollars, to allow for a more meaningful
examination of their movements through time. The Consumer Price Index (CPI) is typically
used for converting nominal income figures into constant dollars.

The Consumer Price Index (CPI)

The CPI is a market price index measuring the price changes of a fixed market basket, which
includes over 400 goods and services representing average household purchases associated
with day-to-day living. Income and social security taxes are excluded, but sales taxes and
user fees are included. There are CPI indices for two consumer groups:

♦ Urban Consumers (the corresponding index is denoted as CPI-U). This group

excludes rural residents, military, and institutionalized population.

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 ♦ Urban Wage Earners (the corresponding index is denoted as CPI-W). This group
is a subset of urban consumers (32%) and includes households with 50% or more
of their income coming from clerical or wage occupations. In addition, at least
one household-head earner must have been employed for 37 weeks during the
previous 12 months.

These two indices are derived from detailed expenditure information provided by
samples of families and individuals. The CPI-U is the most comprehensive index and the
one most often reported by the media. Table 4A.4 presents two CPI-U series, one with 1982-
1984 as the base years and one with 1987 as the base year.

Table 4A.4 Consumer Price Index Series

CPI CPI
Base Years Base Year
1,2
Year 1982-1984 1987 Inflation

1970 38.8 34.2

1971 40.5 35.7 4.4%
1972 41.8 36.8 3.2%
1973 44.4 39.1 6.2%
1974 49.3 43.4 11.0%
1975 53.8 47.4 9.1%
1976 56.9 50.1 5.8%
1977 60.6 53.3 6.5%
1978 65.2 57.4 7.6%
1979 72.6 63.9 11.3%
1980 82.4 72.5 13.5%
1981 90.9 80.0 10.3%
1982 96.5 84.9 6.2%
1983 99.6 87.7 3.2%
1984 103.9 91.5 4.3%
1985 107.6 94.7 3.6%
1986 109.6 96.5 1.9%
1987 113.6 100.0 3.6%
1988 118.3 104.1 4.1%
1989 124.0 109.2 4.8%
1990 130.7 115.1 5.4%
1991 136.2 119.9 4.2%
1992 140.3 123.5 3.0%
1993 144.5 127.2 3.0%
1994 148.2 130.5 2.6%
1995 152.4 134.1 2.8%
1996 156.9 138.1 2.9%
1997 160.5 141.3 2.3%
1998 163.0 143.5 1.5%
1
The annual figures represent averages of the seasonally-adjusted monthly CPI indexes
2
Averaging the CPI indices for 1982, 1983 and 1984 yields 100

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 The CPI index is used to adjust incomes and prices for the effects of inflation or,
alternatively, to convert current-dollar amounts into constant dollars of a base year. Table
4A.5 presents an income-per-worker series in current dollars and its equivalent in 1982-1984
dollars. It also presents the formula for converting current dollars to constant dollars and its
specific use for the calculation of the constant-dollar equivalent of the 1990 income-per-
worker.

Table 4A.5 Converting Income into Constant 1982-1984 Dollars

Personal Personal
Income/ Income/
CPI Worker Worker
Year Base: (in 000s of (in 000s of
(t) 1982-1984 current $) 1982-1984 $)

1970 38.8 10.55 27.19 Income at Year t Current

1971 40.5 11.15 27.54 in Constant Dollars
1972 41.8 11.66 27.91 82-84 = * 100
1973 44.4 12.02 27.08 dollars CPI at t
1974 49.3 12.98 26.33 (82-84 base)
1975 53.8 14.22 26.43
1976 56.9 15.30 26.89
1977 60.6 16.23 26.78 So:
1978 65.2 17.45 26.76
1979 72.6 18.71 25.77 Income in 1990
1980 82.4 20.61 25.01 in Constant 35.42
1981 90.9 22.70 24.97 82-84 = * 100
1982 96.5 24.58 25.47 dollars 130.7
1983 99.6 25.58 25.68
1984 103.9 26.83 25.83
1985 107.6 27.98 26.00 = 27.10
1986 109.6 29.11 26.56
1987 113.6 30.47 26.83
1988 118.3 31.94 27.00
1989 124.0 33.62 27.11
1990 130.7 35.42 27.10

Notice that, as demonstrated in the example portrayed in Table 4A.5, in order to

convert the 1990 income to constant 1982-1984 dollars we need to divide it with the 1990
CPI index that has 1982-1984 as its base years and then multiply the result by 100. But what
if we wanted to translate the 1990 income figure into constant dollars of a different base year,
such as 1970 for example? In that case, we would need a CPI series that has 1970 as its base
year. This series can be calculated from the series that has 1982-1984 as its base years using
the formula in (4A.1):

CPI (t )1982−1984
CPI (t )1970 = *100 (4A.1)
CPI (1970)1982−1984

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 Table 4A.6 presents three CPI series that have different base years (1982-1984, 1970
and 1980). It also presents the general formula for changing the base year of an index to a
new year X and applies this formula to calculate the 1990 CPI figure that has 1970 as its base
year.

Table 4A.6 Changing the Base Year of an Index to Year X

CPI CPI CPI

Year Base Year Base Year Base Year Formula
(t) 1982-1984 1970 1980

1970 38.8 100.0 47.1

1971 40.5 104.4 49.2 Year t's
1972 41.8 107.7 50.7 Index at Old
1973 44.4 114.4 53.9 Index in year t Base Year
1974 49.3 127.1 59.8 at New = __________ * 100
1975 53.8 138.7 65.3 Base Year X
1976 56.9 146.6 69.1 Year X's Index
1977 60.6 156.2 73.5 at old base
1978 65.2 168.0 79.1
1979 72.6 187.1 88.1
1980 82.4 212.4 100.0
1981 90.9 234.3 110.3 So:
1982 96.5 248.7 117.1
1983 99.6 256.7 120.9 Index in
1984 103.9 267.8 126.1 Year 1990 130.7
1985 107.6 277.3 130.6 at New Base = _________ * 100
1986 109.6 282.5 133.0 Year 1970
1987 113.6 292.8 137.9 38.8
1988 118.3 304.9 143.6
1989 124.0 319.6 150.5 = 336.9
1990 130.7 336.9 158.6

Sometimes the analyst may be confronted with the case in which some data are
provided in constant dollars of one year, while some other data are provided in dollars of a
different year. Table 4A.7, for example, presents data on personal income per worker that
are expressed in 1982-1984 constant dollars from 1970 to 1975, and in 1980 constant dollars
for the period 1976-1981. In such a case, any meaningful interpretation of the data requires
that the two series made consistent. This can be done, for example, by converting the data
from 1976 to 1981 to the same base year as the data for the period 1970-1975. In order to do
that we need to apply to the former set of data the formula described by (4A.2):

INCOME1980
INCOME1982 −1984 = * CPI1980 (4A.2)
CPI1982 −1984

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Table 4A.7 demonstrates also how this formula is applied specifically to convert the 1976
income-per-worker figures to 1982-1984 constant dollars.

Table 4A.7 Forming Consistent Time Series when Data are Provided in Constant Dollars
of Different Years
Personal
Income
CPI per worker
Year Base in constant
(t) 1982-1984 1982-1984 $

1970 38.80 27.19

1971 40.50 27.54
1972 41.80 27.91 Year t's Year t's
1973 44.40 27.08 Income in Income
1974 49.30 26.33 constant in 1980 $ Year t's
1975 53.80 26.43 1982-1984 $ = _________ * Index
Year t's at 1980
Index at Base
Personal Personal 1982-1984
Income Income Base
CPI CPI per worker per worker
Year Base Base in constant in constant
(t) 1980 1982-1984 1980 $ 1982-1984 $ Year 1976's
Income in 22.16
constant = * 69.053
1976 69.05 56.90 22.16 26.89 1982-1984 $
1977 73.54 60.60 22.07 26.78 56.90
1978 79.13 65.20 22.05 26.76
1979 88.11 72.60 21.24 25.77 = 26.893
1980 100.00 82.40 20.61 25.01
1981 110.32 90.90 20.58 24.97

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