Sunday, July 27, 2008

The Perils of Non-Diversification

The New York Times had a story on Saturday, "City and State Brace for Drop in Wall Street Pay," about the impact that layoffs and bonus cuts in investment banking will have on the regional and state economies in New York. The story reports that the largest financial companies in New York City will reduce pay and benefits by $18 billion in 2008 compared to 2007. It further reports that earnings in the financial sector account for 10% of the city's tax revenue and 20% of the state's tax revenue. And those are just the direct effects; much of the story talks about the impact that layoffs and lower pay will have on other economic sectors where the financial sector workers spend their earnings. It quotes a state official as saying that each Wall Street job creates two additional jobs in the city and a third in the surrounding region.

These kinds of impacts are reminiscent of the problems the Pittsburgh Region faced in the 1980s with the massive restructuring of the steel industry. In fact, the parallels are quite striking. In the New York metro area today, 12.1% of workplace earnings are generated by the securities industry. In the Pittsburgh metro area in 1980, 13.6% of workplace earnings were generated by the primary metals industry (mostly the steel industry).

Pittsburgh's problem then, and New York's problem today, is an over-dependence on one particular economic sector. But Pittsburgh doesn't have to worry about that any more, right? We've diversified our economy dramatically in the last 25 years, haven't we?

We're clearly less concentrated in manufacturing sectors than we once were. Whereas 13.6% of the Pittsburgh region's workplace earnings in 1980 came from primary metals, only 2.2% do today. And whereas 34% of our workplace earnings in 1980 came from manufacturing, only 13.3% today do, and those are spread across a much broader range of specific industries.

But we've now become heavily dependent on a new sector -- health care. In 2006, 12.5% of the Pittsburgh Region's workplace earnings came from the health care and social assistance sector. That's a higher percentage than the securities industry represents in New York. So our economy is every bit as dependent on the health care industry as New York is on the securities industry. And our region has a higher proportion of its jobs in health care than any of the top 40 regions except for Providence, Rhode Island.

Moreover, most of our job growth recently has been due to growth in the health care sector. Between 2005 and 2007, the total number of jobs in the region increased by 12,700, and 7,300 of those jobs were in the health care sector.

But unlike steel, can't this new goose keep laying golden eggs for us? Probably not. Remember that what's fueling the growth in health care jobs is the rapid escalation in health care costs and health insurance premiums that are making businesses uncompetitive and making health insurance unaffordable. And study after study has estimated that 30-40% or more of health care costs come from waste and inefficiency. Higher and higher priority is now being given to initiatives to lower health care costs by reducing unnecessary hospitalizations, eliminating infections and errors, increasing efficiencies, etc. That means that current growth rates in health care will have to slow, and given our region's dependence on health care for jobs and job growth, that will have a serious effect on our overall economy. The fact that we offer world-class treatments that bring patients here from all over the world will help us somewhat compared to other regions, but there is still likely to be a significant shakeout in the health care sector coming in the next decade.

We should not make the same mistake we made in the 1970s - ignoring the warning signs of over-concentration in an industry that is known to have significant inefficiencies. We need to work hard to make our manufacturing sector more competitive, to help young technology firms to grow and prosper, and to attract new entrepreneurs to the region so we can become truly diversified and better weather any storm in a particular economic sector.


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